Description
Strategic sourcing is an institutional procurement process that continuously improves and re-evaluates the purchasing activities of a company. In a production environment, it is often considered one component of supply chain management.
The strategic sourcing value proposition: A Sasol case study
Johannes Crafford
Research report presented in partial fulfilment of the requirements for the degree of Master of Business Administration at the University of Stellenbosch
Supervisor: Prof. F.J. Herbst
Degree of confidentiality: A
December 2010
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Declaration
By submitting this research report electronically, I, Johannes Crafford, declare that the entirety of the work contained herein is my own work, that I am the owner of the copyright thereof (unless to the extent explicitly otherwise stated) and that I have not previously in its entirety or in part submitted it for obtaining any qualification.
J. Crafford
31 August 2010
Copyright © 2010 Stellenbosch University All rights reserved
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Acknowledgements
I would like to express my sincerest gratitude to my family, Gretel, Stephan and Carla, for their unsurpassed support during my last three years of studies. Thank you to Professor Frikkie Herbst for encouraging me to embark on this course of study. As a specialist in the field of marketing, and this study being in the field of procurement, we are continuously searching for ways to improve our functions’ value-add, labour component and integration into the strategic processes of our organisations. Thank you to my employer, Sasol, for its financial support and encouragement from colleagues and seniors to enrol for my Master’s in Business Administration (MBA) studies. I would also like to thank the following people who committed their time to be interviewed on the subject of this research: Radie van Wyk, Clem Swanepoel, Thiana Bornman, Christa-Marie du Toit, Naas du Preez and Wikus Kritzinger. I would also like to express a kind word to Anne-Marie Schutte for typing this report, Karin Becker for the graphical presentations and Carike Taute and Mariette Nortje for proofreading the final report.
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Abstract
The value-add of a functional department in the corporate environment is continuously being challenged. Functions regularly find themselves in a state of restructuring in order to reduce cost structures which speaks volumes about an organisation’s view of its functions. What is however extremely important to take into account, is that functions can in fact add a great deal of value to the business, but before a function can be recognised as a value-adding partner, it needs to transform itself from a traditional transaction-driven service to a strategic value-adding function which contributes to the business on a strategic level. If this does not happen, the function risks becoming redundant, as most transactional activities today are or at least can be executed in an automated manner. Such a transformation is, however, no easy task, and requires a considerable amount of time to be achieved. It further requires substantial investments, enduring commitment from senior management and specific skills to enable a function to operate at a strategic level. Commitment, investments and new skills on the other hand, do not automatically acquire a seat at the boardroom table for such a function and a place must be earned through accurate proof of the functions value-add in the organisation – the difficult task being expressing that value-add in terms of financial numbers. A function that was confronted with the same predicament was the procurement function of Sasol around 1999, during a time when the commodity prices were under severe pressure and the organisation was looking into alternative ways of improving its cost structure. At this point a decision, to shift the focus of the procurement department from a traditional transactional environment to a value-adding business partner, laid the foundation to re-engineer the function into becoming a value-adding strategic function. A decision was taken to implement strategic sourcing in Sasol as the basis for procurement. This decision required substantial investment and the help of consulting firm McKinsey and Company. The Sasol Board were very confident in its decision, and requested continuous feedback on the actual value that was released through implementation of this new process. This required of the procurement function to develop a model by which the value-add of the process could be measured in real terms. The purpose of this study is to investigate the transformation of the procurement function in Sasol from a traditional transactional function to a strategic value-adding business partner by specifically focusing on the function’s ability to prove its value-add to the organisation, and in so doing, gain respect for being a true strategic value-adding function. Key words: Procurement, value-add, strategic sourcing, total cost of ownership, value chain, supply chain
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Table of contents
Declaration Acknowledgements Abstract Table of contents List of tables List of figures List of acronyms and abbreviations CHAPTER 1 INTRODUCTION AND BACKGROUND 1.1 1.2 1.3 1.3.1 1.3.2 1.4 1.4.1 1.4.2 1.4.3 1.5 1.6 INTRODUCTION DEFINITIONS OF KEY CONCEPTS RESEARCH PROBLEM AND OBJECTIVES Research questions Research objectives RESEARCH DESIGN AND METHODOLOGY Overall design Methodology and data collection Approach to data processing and analysis CHAPTER OUTLINE DELIMITATION AND SCOPE OF STUDY ii iii iv v ix x xi 1 1 3 4 4 5 5 5 6 7 7 8
CHAPTER 2 PROCUREMENT AND STRATEGIC SOURCING’S VALUE-ADD: LITERATURE REVIEW 9 2.1 2.2 2.2.1 2.2.2 2.2.3 2.3 2.4 2.5 2.6 2.7 2.8 INTRODUCTION PROCUREMENT IN CONTEXT Procurement and the value chain Procurement and the supply chain Procurement and strategic sourcing IMPORTANCE OF PROCUREMENT TO AN ORGANISATION TOTAL COST OF OWNERSHIP APPROACH TO STRATEGIC SOURCING DIFFERENT LEVELS OF PROCUREMENT OPERATIONS THE MEASUREMENT OF PROCUREMENT VALUE-ADD KEY LEARNINGS CONCLUSION 9 9 9 10 12 13 16 17 20 21 22
CHAPTER 3 CREATING A VALUE-ADDING PROCUREMENT FUNCTION THROUGH THE IMPLEMENTATION OF STRATEGIC SOURCING: THE SASOL CASE 23 3.1 3.2 3.3 INTRODUCTION THE CASE FOR CHANGE PROJECT PHASE 23 23 24
vi 3.3.1 3.3.2 3.3.3 3.4 3.4.1 3.4.2 3.5 3.6 3.7 Structure Identifying the key commodities to focus on The value team process POST-PROJECT PHASE Transformation of the procurement function The current procurement environment in Sasol VALUE ADDED BY STRATEGIC SOURCING IN SASOL Key learnings CONCLUSION 25 26 27 29 30 31 33 34 35
CHAPTER 4 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: TOTAL COST OF OWNERSHIP MODEL 37 4.1 4.2 4.3 4.3.1 4.3.2 4.4 4.4.1 4.4.2 4.4.3 4.4.4 4.5 4.5.1 4.5.2 4.5.3 4.5.4 4.6 4.7 INTRODUCTION TOTAL COST OF OWNERSHIP AS BASIS FOR MEASUREMENT TOTAL COST OF OWNERSHIP BASELINE ADJUSTMENT Market adjustment Activity adjustment 37 38 41 41 46
APPLICATION OF THE TCO MODEL AS A MEASUREMENT TOOL FOR THE VALUE CREATED BY STRATEGIC SOURCING: CRUDE OIL 47 Elements of the Crude Oil TCO model Activity adjustment Market adjustment TCO Comparison PROBLEMS IDENTIFIED WITH TCO MEASUREMENT Linking of benefits to financial statements Availability of data Establishing a market index and activity adjustment Time and resource constraints Key learnings CONCLUSION 47 49 49 51 52 52 53 53 53 54 54
CHAPTER 5 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: SASOL BENEFITS MODEL 55 5.1 5.2 5.2.1 5.2.2 INTRODUCTION BENEFIT CATEGORIES Sustainable versus once-off benefits Five requirements of benefits calculations 55 55 56 58 58 59 59
5.2.2.1 Mutually exclusive, comprehensively exhaustive (MECE) 5.2.2.2 TCO model 5.2.2.3 Activity level
vii 5.2.2.4 Indices 5.2.2.5 Baseline 5.3 5.3.1 5.3.2 5.3.3 5.3.4 5.4 5.4.1 5.4.2 5.4.3 5.4.4 5.5 5.6 6.1 6.2 6.2.1 6.2.2 6.2.3 6.3 6.3.1 BENEFITS MODEL TCO reduction Idea tracking Price containment Once-off SASOL BENEFITS GOVERNANCE PROCESSES Target setting Reporting of benefits Benefits sign-on process Auditing of benefits Key learnings CONCLUSION INTRODUCTION KEY REQUIREMENTS FOR AN EFFECTIVE PROCUREMENT FUNCTION Vision Purpose Value proposition THE HIERARCHY OF AGENDAS FOR THE SASOL PROCUREMENT FUNCTION Foundation 59 59 60 60 61 61 61 62 62 62 63 65 66 66 67 67 67 67 68 69 70 71 71 72 72 72 73 73 73 73 74 74 75 75 75
CHAPTER 6 SUSTAINING A WORLD-CLASS FUNCTION
6.3.1.1 Stakeholder relations 6.3.1.2 Standardised processes 6.3.1.3 Governance 6.3.1.4 Contract management 6.3.1.5 ERP system support 6.3.1.6 Skills development 6.3.2 6.3.3 6.3.4 6.4 6.5 6.6 6.7 Securing of supply Sustain benefits already achieved New benefits DEFINITION OF VICTORY (DOV) STRATEGIC SOURCING AND THE GLOBAL ECONOMIC CRISIS Key learnings CONCLUSION
viii CHAPTER 7 CONCLUSION, KEY INSIGHTS AND RECOMMENDATIONS FOR FUTURE RESEARCH 77 7.1 7.2 7.2.1 7.2.2 7.2.3 7.2.4 7.2.5 7.2.6 7.2.7 7.3 7.4 INTRODUCTION KEY LESSONS LEARNT Procurement can add substantial value to an organisation Strategic sourcing is not a project, but a new business process Effect of the market and activity levels on a commodity Value released can be once-off or sustainable Importance of governance in a strategic sourcing process Total functional value-add important to stay relevant Strategic sourcing creates a platform from which to respond in times of crisis RECOMMENDATIONS FOR FURTHER RESEARCH CONCLUSION 77 78 78 79 79 79 79 79 80 80 80 82 86 98 103 108 115 121
REFERENCES APPENDIX A TRANSCRIPT OF INTERVIEW MR RADIE VAN WYK APPENDIX B TRANSCRIPT OF INTERVIEW WITH MR CLEM SWANEPOEL APPENDIX C TRANSCRIPT OF INTERVIEW WITH MS THIANA BORNMAN APPENDIX D TRANSCRIPT OF INTERVIEW WITH MS CHRISTA-MARIE DU TOIT APPENDIX E TRANSCRIPT OF INTERVIEW WITH MR NAAS DU PREEZ APPENDIX F TRANSCRIPT OF INTERVIEW WITH MR WIKUS KRITZINGER
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List of tables
Table 2.1: Effect of improvement in various areas of the business on the return Table 4.1: Cost elements of Crude Oil TCO model Table 4.2: Percentage change in crude oil price with July 2007 as base Table 4.3: Statistical results of regression analysis Brent Oil and Spot Purchase Table 6.1: Sasol procurement function purpose Table 6.2: Value release to key stakeholders by procurement Table 6.3: Sasol Procurement DOV 13 49 50 51 68 70 74
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List of figures
Figure 2.1: Porter’s Value Chain Figure 2.2: Value chain vs. supply chain Figure 2.3: Percentage impact created by procurement effort Figure 2.4: Evolution of procurement function Figure 2.5: Evolution of procurement at TATA Steel Figure 3.1: Comparison between value team and strategic sourcing teams Figure 3.2: Sasol value team process Figure 3.3: Evolution of Sasol’s procurement function Figure 3.4: Sasol total spend on goods and services 2009 Figure 3.5: Movement in spend for Sasol South Africa Figure 3.6: Value released by strategic sourcing 2000 to 2009 Figure 4.1: The TCO cost buckets Figure 4.2: TCO vs. Total cost of goods and services Figure 4.3: Year-on-year TCO reduction Figure 4.4: TCO baseline adjustment Figure 4.5: PPI movement vs. relevant commodity index for electrical motors in Sasol Figure 4.6: Developing an independent commodity index Figure 4.7: Development of an independent commodity index for electrical motors in Sasol Figure 4.8: Purchasing life cycle cost elements for crude oil Figure 4.9: TCO of crude oil in Sasol July to December 2008 10 11 14 17 19 25 27 31 32 33 34 38 39 40 41 43 44 45 48 48
Figure 4.10: TCO comparison for crude oil in Sasol July to December 2008 vs. July to December 2009 52 Figure 5.1: Classification of benefits in Sasol Figure 5.2: Sustainable benefits illustration Figure 5.3: Once-off benefits illustration Figure 5.4: Five requirements for benefits calculation Figure 5.5: The Sasol Benefits Model Figure 5.6: Benefit sign-on document Figure 6.1: Hierarchy of agendas 56 57 57 58 60 64 71
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List of acronyms and abbreviations
CEO DOV EBIT ERP GM HOA KPI MBA MD MECE NGIS PPI RFP SA SAP SEIFSA TCO UNISA UNSPC chief executive officer definition of victory earnings before interest and taxes enterprise resource planning general manager hierarchy of agendas key performance indicators Master’s (degree) in Business Administration managing director mutually exclusive, comprehensively exhaustive NetGain information system producer price index request for proposal South Africa
Systems Applications and Products (ERP system) Steel and Engineering Industries Federation of South Africa total cost of ownership University of South Africa United Nations Standard Products and Services Code
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CHAPTER 1 INTRODUCTION AND BACKGROUND
1.1 INTRODUCTION
What is the value that a functional department adds to the bottom line of an organisation? This is a question that is continuously asked in the corporate world. The question is put to all functions: human resources, procurement, finance, marketing and academic literature continuously reiterates the value-add of functions as key focus areas. In an organisation, every manager has to build a case to demonstrate why a function is an essentially required part of the corporate strategic processes and prove the unique value that the function adds to the organisation. A particular function, which for many years was seen as a mere service department, is the procurement function. According to Hardt, Reinecke and Spiller (2007: 1), the McKinsey global survey of chief procurement officers suggests that the role of procurement in many organisations has not evolved much beyond the traditional transactional focus: as buyers of materials, components and services. Some procurement functions, however, have attracted the attention of senior management in their organisations, by taking the functions to an elevated level. By means of integrating their activities more closely with those of their internal customers, these procurement functions have gained sustainable cost reduction benefits in areas that were not traditionally the focus areas of procurement. Due to the roller coaster economic environment that many industries have experienced since the late 1990s, executives were forced to re-examine the procurement environment as a source of enhancing an organisation’s competitiveness. In the late 1990s many manufacturers faced the reality of low commodity prices which put tremendous pressure on bottom-line earnings. Then, by the mid 2000s, the world experienced a boom in commodity prices, but the upward trend ended dramatically with the 2008 economic crisis. These realities, combined with the pressures of globalisation, forced organisations to carefully examine their input costs in an effort to become more competitive. The traditional once-off costcutting exercises would not be adequate any more as suppliers alike were faced with the same issues and challenges. The procurement function required re-engineering to become a true value-adding partner in business and this has become one of the top priorities in many organisations today. Transforming a procurement function into a true value-adding partner is however no easy task, and deciding at which level of strategic value-add a function is supposed to operate, is a purposeful
2 decision an organisation needs to take. A further important consideration is the measurement of the value-add by the procurement function as a means of proving its worth to the organisation. In South Africa, Sasol was faced with a particular challenge at the end of the 1990s: very low crude oil prices. Sasol needed to re-engineer its procurement function in order to reduce input costs by R400 million. A decision was made at board level to implement strategic sourcing as a business process in the procurement function. Strategic sourcing focuses on detail strategy formulation for key commodities in order to reduce the total cost of ownership (TCO) of that commodity. Sasol’s chief executive officer (CEO) at the time, Mr Peter Cox, introduced a process in terms of which the whole organisation was re-organised in a way specifically aimed at reducing input costs. This was the burning platform which demanded the re-engineering of the procurement function and validated the introduction of the process of strategic sourcing. The above scenario played out against the background of a very traditional environment in which most of Sasol’s businesses were decentralised and procurement was performed independently by each business unit. This meant that very little economy of skill and scale were applied. Sasol was organised in silos, which meant that maintenance, production and the various functional departments each functioned independently from each other with each silo focusing on its own performance metric. According to Van Wyk (2010), with the implementation of strategic sourcing and the application of the principles of TCO reduction in Sasol, procurement became enabled to break down these silos and in the process leverage the two crucially important levers: economy of skill and economy of scale. The effect thereof was that the company reported R3.8 billion in value (Kritzinger, 2010) realised from the inception of strategic sourcing to date. After its initial success, the business process was also implemented in a European affiliate when Sasol acquired Condea. The procurement function played a fundamental role in the integration of the newly acquired company into the Sasol Group. According to Hardt et al., (2007: 2), procurement’s tactical potential as a cost killer is well known, and in many companies spend on goods and services accounts for more than 70 per cent of the company’s cost structure. Business leaders have realised that any improvement in the procurement activity of an organisation will have a direct impact on the organisation’s bottom line. The result thereof is a change in the way in which the value proposition of procurement is seen. Where the procurement function traditionally offered only price-containment based on the principle of squeezing a supplier for better prices, this framework of sourcing on the other hand, recognises that the value proposition of procurement is limited to only one aspect, namely the price of a commodity. By implementing strategic sourcing as a process with a total cost of ownership (TCO) focus, various other levers now become available to procurement, namely the usage of a commodity by end users, challenging the specifications of a commodity and working closely with a
3 supplier to stay abreast of improvement options. These levers, amongst others, assisted Sasol in achieving the benefits mentioned above. In academic literature, the importance of procurement and strategic sourcing in an organisation is described in great detail, but very little time is spent on the creation of world-class procurement functions and measurement of the value-add that such a strategic focus brings to an organisation. The intent of this study is to analyse the implementation of strategic sourcing in Sasol as a case study, and to develop a framework for consideration when an organisation decides to embark on the implementation of strategic sourcing as a business process. In addition, the research study will attempt to develop a model for measurement of the value-add that procurement as a function brings to an organisation based on what has been developed in the industry and which may fill the above-mentioned lack of information in literature. 1.2 DEFINITIONS OF KEY CONCEPTS
To ensure that this research study is understood by all readers, the following key concepts are defined and clarified below: i) Benefits
This refers to the value released by reduction of the TCO of a commodity, on a year-on-year basis after making provision for the movement in market prices and activity level. It is the difference between base TCO and the current TCO (Sasol, 2010a: 6). ii) Goods and services
Goods and services are used as a collective concept and include utilities, energy, logistics and raw materials. iii) Procurement and purchasing
These words are used interchangeable and refer to the process of acquiring goods and services. iv) Procurement function
The functional department in an organisation responsible for the processes by which goods and services are procured for the organisation (Hugo, Van Rooyen & Badenhorst, 2001: 5). v) Strategic sourcing
This refers to the collaborative and structured process of critically analysing an organisation’s spending and using this information to make business decisions about acquiring commodities and services more effectively and efficiently (Fox, 2006: 1). vi) Total cost of ownership (TCO)
This includes all costs arising from the procurement, utilisation, maintenance and disposal of a product (Schuh, Kromoser, Strohmer, Perez & Triplat, 2008: 181). vii) Total value of ownership
4 This refers to the total value created to the organisation by acquiring a specific commodity and utilising it in the most effective manner (Bhargava, Koch, Pley & Pathak, 2008: 2-3). 1.3 RESEARCH PROBLEM AND OBJECTIVES
The research problem was identified against the background of an ever changing economic environment in which an organisation needs to remain competitive. The procurement function has been identified as one of the primary areas in which management can leverage economies of skill and scale to be more effective, efficient and competitive in the market place. The research study investigates one of the most successful procurement functions in South Africa, namely that of Sasol, to determine the elements required to create a value-adding function through the implementation and facilitation of a strategic sourcing approach. For purposes of this study, specific focus is placed on the framework of decisions for consideration, as well as the actual measurement of the value-add as a product of the process. In order to put everything in context, the Sasol case study is examined from the point where the board of directors made the decision to implement strategic sourcing as a business process, including all the knowledge gained through implementation of the process up to today. Special focus is allocated to the specific measures that were put in place to sustain the value-add that the process offers. 1.3.1 Research questions
In light of the description of the research problem, the primary research question is defined as follows: How do you create a value-adding procurement function in an organisation through the implementation of strategic sourcing and how do you measure the value-add as a product of the process? The following secondary research questions follow from the primary research question to further define the focus of the research: ? ? ? ? ? ? How important is procurement in an organisation? When is it warranted for an organisation to embark on strategic sourcing? How do you establish a business case for strategic sourcing? Who are the role players who ensure that value is being released? What is the framework to consider when a decision on strategic sourcing needs to be taken? What is the role of total cost of ownership in the strategic sourcing process?
5 1.3.2 Research objectives
The objectives of the research study are as follows: ? ? ? ? ? ? Study the theory of procurement and gain insight into the value-add of procurement as a function; Explore the Sasol knowledge gain, acquired through transformation of its procurement function with the implementation of strategic sourcing; Understand the value-add in Sasol as a result of implementing this business process; Plot the theoretical learning against the practical experience and knowledge gained in Sasol; Gain understanding of the factors that must be considered before implementation of strategic sourcing; Gain detailed understanding of the model used in Sasol to measure the value-add of the procurement function. 1.4 1.4.1 RESEARCH DESIGN AND METHODOLOGY Overall design
The research design of this report should be regarded as empirical, and was conducted in the form of a single case study. According to Saunders, Lewis and Thornhill (2007: 137) a case study is a strategy for doing research, which involves an empirical investigation of a particular contemporary phenomenon within its real life context. The re-design of the procurement function in Sasol was used as the case study. The Sasol case study provides a real life example of an organisation that embarked on a process of re-engineering its procurement function and also addresses the issue of measuring the value-add of the newly structured procurement function. Current text books do not provide for this methodology of tracking. The reason for deciding on Sasol as subject of the case study is that it has succeeded in realising more that R3.8 billion in benefits over the last ten years through implementing and executing strategic sourcing as a business process in the organisation. The Sasol procurement function has also been rated by McKinsey and was positioned in the top ten per cent of companies surveyed globally in the last two years. Sasol has agreed to the use of its data and experience.
6 1.4.2 Methodology and data collection
The information for this study was obtained by means of qualitative research. Qualitative data refers to non-numerical data or data that has not been quantified (Saunders et al., 2007: 608). The process of data collection involved primary data collection from internal Sasol reports such as audit reports, strategic workshop presentations, board reports, monthly reports and internal material. Interviews were conducted with key personnel who were involved in the re-engineering of the procurement function during the inception of strategic sourcing, to gain greater insight into the strategic thinking process utilised to embark on this journey and to identify key experiences which were used to create a framework for analysing a proposal to consider the implementation of strategic sourcing as business process. The interviews form an integrated part of the data collection and the following people were identified: i) Radie van Wyk
Mr Van Wyk is currently an independent consultant in the field of strategic sourcing. He was the project leader between 1999 and 2002 when Sasol decided to implement strategic sourcing. Mr Van Wyk played a key role in the establishment of the process within Sasol as well as lobbying with senior management to embark on this process. ii) Clem Swanepoel
Mr Swanepoel was originally a member of Sasol’s finance department, but during the implementation of strategic sourcing in the group, became a member of the project team with specific focus on the measurement of the value-add of strategic sourcing. iii) Thiana Bornman
Ms Bornman manages the Procurement Centre of Excellence in the Sasol Group. She is responsible for procurement governance and adherence to strategic sourcing processes in the Sasol Group. Ms Bornman was a member of the original project team tasked with the implementation of strategic sourcing in Sasol. iv) Christa-Marie du Toit
Ms Du Toit is a subject matter expert who mans the Centre of Excellence for Commodity Indices. She is responsible for the governance with regards to, and establishment of commodity indices which form an integral part of the tracking of the strategic sourcing value proposition in Sasol. v) Naas du Preez
Mr Du Preez is currently an independent consultant in the field of strategic sourcing with clients such as Anglo American, Anglo Platinum and Harmony Gold. Mr Du Preez was the commercial manager at Sasol in 1999 during the initiation of the process. He was later involved in the roll-out of the process to Sasol Europe.
7 vi) Wikus Kritzinger
Mr Kritzinger is currently the Global General Manager for Supply Chain in Sasol. One of his areas of responsibility is the procurement function. The interviews were recorded to ensure that all data is captured and used accurately. All interviews were transcripted and edited. The edited versions were returned to the interviewees for purposes of sign-off on the content thereof. The transcripts of these interviews can be viewed in Appendices A to F. 1.4.3 Approach to data processing and analysis
Handling of data includes a summary of the respective interviews. It includes analysis of the latter against the background of relevant literature in order to answer the research question posed. 1.5 CHAPTER OUTLINE
Chapter 1 focuses on the research problem and objectives as well as the research design and methodology followed. Chapter 2 focuses on the comprehensive literature study with the main focus on the importance of procurement in an organisation and how procurement has evolved over the last 20 years into a true value-adding function. The researcher also focuses on procurement as a key element in the value chain as described by Porter (Business Policy, 2010: 2) and then looks at strategic sourcing as a business process in the procurement function. One of the key concepts of strategic sourcing is the concept of total cost of ownership (TCO), which is explored and proven to be of fundamental importance in strategic sourcing decision making. The researcher also looks at the measurement of value-add in the procurement function and the role that procurement can play as a strategic partner on board level in an organisation. Chapter 3 focuses on the Sasol case study with the intention of aligning the theory developed in Chapter 2, with the practical experience in Sasol. In this chapter, the researcher examines the reasons on which implementation of the process in Sasol was based, the case for change and the business case that was developed which lead to the management decision to embark on implementation thereof in Sasol. In Chapter 3 the researcher tries to answer the secondary research questions of: ? ? ? ? How important is procurement in an organisation? When is it warranted for an organisation to embark on strategic sourcing? How do you establish a business case for strategic sourcing? Who are the role players who ensure that value is being released?
8 The researcher also looks at how the procurement function in Sasol evolved over time compared to the evolution model discussed in Chapter 2. In this chapter the reader is also introduced to the value that the process has yielded for Sasol. Chapter 4 focuses on the measurement of strategic sourcing’s value-add based on the TCO model. In Chapter 5 the principles, as refined by Sasol in order to make the measurement more effective and less time consuming, are discussed. It is also proposed that this model be adopted in academic literature as there is currently no reference in literature on how the value created by strategic sourcing can be measured. Chapter 6 looks at the elements Sasol had to put in place to ensure that the procurement function stays relevant and remains a world-class function, and the building blocks required in order to ensure a sustainable function in the long run. Finally, Chapter 7 summarises the findings and provides recommendations for future research. 1.6 DELIMITATION AND SCOPE OF STUDY
The study is aimed at defining the value contribution a procurement function brings to an organisation by using Sasol as a case study. The focus is concentrated to the case factors for consideration when pondering a decision to implement strategic sourcing as a business process. The actual implementation and change management in an organisation, as well as the restructuring of the procurement function and acquisition of the required skills, are key success factors, but it will not be addressed in this study and may be considered as a possible area for future research.
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CHAPTER 2 PROCUREMENT AND STRATEGIC SOURCING’S VALUE-ADD: LITERATURE REVIEW
2.1 INTRODUCTION
Four steps to achievement: Plan purposefully. Prepare prayerfully. Proceed positively. Pursue persistently ~William A. Ward. This chapter analyses a comprehensive literature study, focusing on the importance of procurement in an organisation, and how procurement has evolved over the last 20 years into a true value-adding function. The level to which this function has evolved, differs between organisations, mainly due to the fact that an organisation needs to make a purposeful decision about the level at which it would like to see its procurement function operate and the value proposition expected from the function. The researcher investigates Porter’s Value Chain Model (Business Policy, 2010: 1) which includes procurement as one of the nine activities that can create a competitive advantage in an organisation. The researcher also investigates the process of strategic sourcing, its relation to the procurement function and investigates the concept of total cost of ownership (TCO) as an important strategic sourcing decision-making tool. Lastly, the researcher looks at the methodology behind the measurement of the value-add in an organisation by its procurement function. 2.2 PROCUREMENT IN CONTEXT
In academic literature the concepts of value chain, supply chain, procurement and strategic sourcing are being used interchangeably which leads to confusion to the reader. In the next part of the research report the researcher attempts to distinguish between these concepts and defines procurement and strategic sourcing within the context of the broader value chain and supply chain concepts. 2.2.1 Procurement and the value chain
The value chain concept was developed by Porter (1985) in his book “Competitive Advantage” through which he defined “value” as the amount a customer is willing to pay for a product offered by the organisation, and the “value chain” as the nine generic activities within an organisation which work together to create this value to the customer (Feller, Shunk & Callarman, 2006: 1). The idea of the value chain is based on the process flow of inputs, transformation and outputs, and how these activities are carried out, determines the cost of a product and effects profit to the organisation .
10 The value chain activities of Porter (Business Policy, 2010: 2) are split into primary activities and support activities, and the extent to which organisations are able to conduct the activity in a distinct manner will determine the level of competitive advantage of the organisation. Porter’s Value Chain activities are illustrated in Figure 2.1 below, which describes the primary and support activities.
Firm infrastructure Margins Human resource management Technologies Procurement Margins
Support activities
Inbound logistics
Operations
Outbound logistics
Marketing & Sales
Services
Primary activities
Figure 2.1: Porter’s Value Chain Source: Porter, 1985: 37. An organisation can create a competitive advantage for itself by optimally focusing on the nine activities in two ways, namely: by creating a cost advantage for itself or by differentiation (Business Policy, 2010: 2). The cost advantage is achieved by understanding the cost structure and squeezing cost out of the activities. Differentiation is achieved by focusing on those activities where the organisation has a core competency. One of the nine activities which can assist an organisation in achieving a competitive advantage, is procurement. In the model, procurement refers to the function of purchasing and not to the procured inputs itself (Business Policy, 2010: 2). 2.2.2 Procurement and the supply chain
According to Hanna and Newman (2007: 68) supply chain can be defined as “every effort involved in producing and delivering a final product and service, from the supplier’s supplier to the customer’s customer. Supply chain management includes: managing supply and demand, sourcing of raw materials and parts, manufacturing and assembly, warehousing and inventory tracking, order entry and order management, distribution across all channels, and delivery to the customer.”
11 Burt, Dobler and Starling (2003: 7) define the supply chain as follows: “Supply system includes all internal functions plus external suppliers involved in the identification and fulfilment of the needs to materials, equipment and services in an optimised fashion.” Thus, from this definition, it is clear that the supply chain is a system of functions, plus external suppliers, which form an integrated chain in order to service customers. As in the value chain definition of Porter (Business Policy, 2010: 2), procurement again is a vital element in the supply chain definition of Hanna and Newman (2007:68). But is there a difference between the value chain and supply chain concepts, or does procurement play a different role in these concepts? Feller et al. (2006: 4) state that the primary difference between a supply chain and a value chain is a fundamental shift in the focus from the supply base to the customer. Supply chain focuses upstream on integrating supplier and producer processes, while improving efficiency and reducing waste, while value chain focuses downstream on creating value according to the customer’s view of value. Feller et al. (2006: 2) illustrate this principle as follows in Figure 2.2:
Product
Customer Requirements Value Chain
Input Material
Manufacturing
Finished Product
Customer
Supply Chain Product Requirements Customer
Figure 2.2: Value chain vs. supply chain Source: Feller et al., 2006: 4. Procurement can thus be referred to as the function of purchasing of raw materials and other inputs used in the value creation activities (QuickMBA, 2010: 2).
12 According to Hugo et al. (2001: 4-5), a function consists of a group of related activities which are grouped together to achieve a specific objective. The procurement function deals with those activities that have to be performed in order to ensure that suppliers provide an organisation with the right requirements, in the right quantities, at the right time and place, and at the best price. Amor (2010: 1) points out that this well-known definition was adjusted on Wikipedia by changing the best price concept to total cost of ownership, and it reads as follows: “Procurement is the acquisition of goods and/or services at the best possible total cost of ownership, in the right quantity and quality, at the right time, in the right place and from the right source for the direct benefit or use of corporations or individuals.” According to all of the above definitions, procurement has to do with the interaction with a supplier to acquire the goods and services needed to produce the products a customer needs, and which activity, according to Porter (Business Policy, 2010: 3), can render a competitive advantage for an organisation by means of either cost reduction or differentiation. From the above it is clear that the value chain concept is based on creation of value to the customer by providing a product that satisfies its needs, while the supply chain concept refers to the flow of material to produce a product and deliver it to customers as per the Hanna et al. (2007: 68) definition. Hence the conclusion that the concept of value chain is different to that of supply chain, but the role that procurement plays in both environments are the same and therefore falls within the definition according to Hugo et al. (2001: 4 – 5). 2.2.3 Procurement and strategic sourcing
According to Stock and Lambert (2001: 480) the strategic role of a procurement function is to perform sourcing activities in a way that supports the overall strategic objective of an organisation. Procurement can play a key role in the strategic success of an organisation due to the fact that is one of the organisation’s functions that spans beyond company boundaries (Stock et al., 2001: 480). One approach to procurement is strategic sourcing. According to Laxton (2010: 1) strategic sourcing is a business process that evaluates and assesses the procurement activities of a company on an ongoing basis. It is a systematic process focused on getting the maximum value from a cost- , quality- and technology perspective by leveraging the organisation’s buying power. According to Fox (2006: 1): “Strategic sourcing is an collaborative and structured process of critically analysing an organisation’s spending and using this information to make decisions about acquiring commodities and services more effectively and efficiently.”
13 Sasol (2004: 3) defines strategic sourcing as a process that involves a total cost of ownership approach, to the management of key commodities. It can be summarised as a business optimisation process that highlights value-add resulting from constantly looking at better ways of doing things – thus procuring things. According to Laxton (2010: 1) the strategic sourcing process starts with the evaluation of an organisation’s spend base, analysing the supply markets and a detailed cost analysis. These all form part of the intent to generate savings from the sourcing process. 2.3 IMPORTANCE OF PROCUREMENT TO AN ORGANISATION
Procurement plays an important role in most organisations since the procurement of parts, components and raw materials represent between 40 and 60 per cent of a final product’s sales value (Ballou, 2004: 447). The effect thereof is that any small cost contribution gained in the procurement of goods and services can have a great impact on the profits of an organisation. Leenders and Blenkhorn (1998: 8) suggest that in every organisation, public or private, procurement can add substantial value to the bottom line as spend on goods and services accounts for a substantial percentage of the total turnover of any company. Very few companies’ total spend is less than 20 to 30 per cent of turnover. Chapman, Dempsey, Ramsdell and Reopel (1997: 31) confirm this with their view on the subject that the average spend in an organisation on goods and services is in the order of 50 to 80 per cent of turnover and that second to pricing, the reduction of purchasing costs is the most powerful way in which an organisation can improve its bottom line. Based on the experience of the authors, a ten per cent improvement in the cost of goods and services can lead to an increase of up to 22 per cent in the earnings of a company, compared to the only 16 per cent increase by decreasing labour cost. Figure 2.3 illustrates the effect of the ten per cent improvement in the various areas of focus on the company’s bottom line. Table 2.1: Effect of improvement in various areas of the business on the return
10% Improvement Pricing Purchased materials Market share Labour expenses Other expenses Fixed assets Working capital Increase returns by 30% 22% 17% 16% 11% 11% 11%
Source: Chapman et al., 1997: 32.
14 A fact that is clear from the above figures, is that only the pricing strategy for the final product sold can generate more value to an organisation than the procurement of goods and services. It is evident from the above that the percentage spend on goods and services, is a determining factor in the calculation of the potential value-add of a procurement function within an organisation. If there is no substantial spend base, this value proposition does not exist. Bhargava, Koch, Pley and Pathak (2008: 58) illustrate the value-add to a company’s bottom line in Figure 2.3 below:
120
100 100
10
70% - 90% increase in EBIT
17 - 19 7-9 81 - 83 100
80 45 60
Goods & Services
40
20
45
Salaries
0 Turnover EBIT before Procurement effort Spend base TCO reduction Spend after Procurement effort EBIT after Procurement effort Turnover
Assumptions: 10% EBIT Margin 50/50 split between labour cost and goods & services
Figure 2.3: Percentage impact created by procurement effort Source: Adapted from Bhargava et al., 2008: 58. As illustrated in Figure 2.3 above, the potential impact of a seven to nine per cent improvement created by the procurement effort in an organisation, can have a substantial impact on the earnings before interest and tax; possibly as high as 70 to 90 per cent. The procurement effort mentioned is a total cost of ownership (TCO) reduction which is discussed in paragraph 2.4 below. The illustration in Figure 2.3 is based on an organisation with a turnover of 100, with earnings before interest and taxes (EBIT) of ten units. This indicates a spend base of 90 consisting of a 50/50 split between labour cost and cost of goods and services. If the procurement function is now able to achieve a TCO reduction of seven to nine units, the spend will reduce to between 81 and 83 units. Where the turnover remains unchanged, the procurement effect adds seven to nine units directly to the EBIT, thus an increase of 70 to 90 per cent in EBIT.
15 This reflects the value proposition of a procurement function which needs to be leveraged in order to support Porter’s view that procurement can be a value-adding function that creates a competitive advantage for an organisation. Hugo et al. (2001: 10-11) identified that procurement’s importance has grown in most organisations due to the ever-increasing scope of material costs in relation to other cost elements and the need for cost savings. According to Hugo et al. (2001: 10-11) the following are the primary contributory factors in South Africa: i) Inflation: In South Africa this has been a problem since the 1970s and organisations need to continuously focus on their costs in order to stay competitive; ii) iii) Tough competition: Due to global competition, organisations need to have a cost focus; Shortage of requirements: Securing of supply is a constant problem and organisations need to look at substitutes and alternative sources of supply; iv) International characteristics: Supply sources are more global and consequently South Africa and its producers are more exposed to the fluctuating values of monetary units; v) vi) Supply risk: Due to global growth, supply risk is a continuous reality; Price control: Some countries have imposed tariff protection to its local industries which means that, for South African organisations to compete, they need to reduce their cost structure; vii) Technological revolution: Continuous research and development provide new products which may leave others obsolete if the life cycle of the product procured is not managed properly; viii) Stringent quality specifications and controls: The re-use of materials is increasingly in demand and procurement management have to take careful note of this; ix) Development cost: This continues to increase and to ensure successful marketing of products, the procurement department’s input has become a necessity in the development phase of a product, especially with regards to materials input and their functional suitability; x) Inventory costs: Unnecessary inventory ties up capital. Procurement and procurement planning play a crucial role to reduce inventory cost. Keough (1993: 3) identified four barriers which explain why organisations battle to implement strategic sourcing namely: i) Poor information: Most companies can not answer the most basic of questions, such as how much is spent on goods and services; ii) Weak administration: Most procurement functions are overwhelmed by day-to-day procurement activities; iii) Lack of skills: Procurement functions do not invest in the proper strategic skills required to implement strategic sourcing; iv) Low status: The procurement function is not traditionally seen as a career growth environment.
16 2.4 TOTAL COST OF OWNERSHIP APPROACH TO STRATEGIC SOURCING
The total cost of ownership (TCO) approach to strategic sourcing means that when procuring a commodity, the focus is on all the cost elements related to that commodity over its lifetime and the intent of strategic sourcing is to reduce that TCO of the commodity for the company on a year-onyear basis. This is the basis of the value-add resulting from a strategic sourcing process. TCO encompasses all the costs arising from the procurement, utilisation, maintenance and ultimate disposal of a product within a company (Schuh, Kromoser, Strohmer, Perez & Triplat, 2008: 181). Amor (2010: 1) views procurement decisions based on TCO assessments to be more effective than those based on the cost of purchase. Hidden costs always pose a problem over the long term. Ensuring that all costs are included, makes for a better comparison of supplier offerings (Schuh et al., 2008: 181). Through the process of strategic sourcing, the entailed concept includes an identification of all the cost elements, and then, by working closely with the suppliers and end users of the commodity, the development of plans to continuously reduce the TCO of the commodity and by so doing, realise value for the organisation. According to Burt et al. (2003: 160) “TCO should be a permanent concept in every supply management professional’s mind, whether in a service, retail of manufacturing firm.” Burt et al. (2003: 164-170) make a distinction between three components of TCO: i) Acquisition costs
This is the initial cost associated with the procurement of goods and services. It represents the immediate cash outflow and includes costs like purchase price, planning costs, taxes and financing costs. ii) Ownership costs
These are the costs incurred after the purchase of the goods and services, and are associated with the ongoing use of these goods and services. These costs include cost elements like energy usage, downtime, scheduled maintenance, repair and financing cost. iii) Post ownership costs
Post ownership costs include cost elements like salvage- and disposal cost, which is becoming more relevant in practice. Some examples are environmental costs, product liability costs and customer dissatisfaction costs. The concept of TCO is relevant, not only from a cost reduction point of view, but also from a design point of view, especially if the focus is to create a product that has the lowest TCO for the customer. According to Schuh et al. (2008: 182) the TCO strategy can lead to value creation partnerships of which the focus is not exclusively on price reduction. TCO also helps to eliminate activities in the
17 life cycle of goods and services, which do not contribute value. The savings potential through the strategic sourcing process can be more accurately predicted by TCO than by any other means. Schuh et al. (2008: 183) further states that the TCO concept forms an integral part of the strategic sourcing process and no proper sourcing decision can be made in the absence of a properly constructed TCO model. From the available literature it is clear that a procurement function can add extensive value to the organisation, especially if an organisation decides to adopt a strategic sourcing approach to procurement and that strategic sourcing decision is based on a TCO approach. What is also clear, however, is that an organisation needs to make a purposeful choice with regards to the level at which it expects its procurement function to operate, and then make such a decision part of its senior management’s strategic agenda. 2.5 DIFFERENT LEVELS OF PROCUREMENT OPERATIONS
This section investigates the different levels of procurement operations, from which an organisation could choose and make a functional decision about. In the literature there are various models portraying different phases into which a procurement function can evolve over time. All these models start with a typical transactional focus, which evolves over time into a strategic sourcing focus. In this section the focus will be on Keough’s (1993 :1) model which was published in 1993 and the procurement evolution model of TATA Steel which was developed in 2004. According to Keough (1993 :1) there are various stages of evolution in a procurement function. The five stages are described in Figure 2.4 as well as the level of value-add to the organisation and the characteristics of the various stages.
Stages of evolution Valueadd Focus Keep plant running Minimise cost Lower cost by leveraging economies of scale Specification, design, supplier development Strategic supplier selection Serve the factory Lowest unit cost Coordinated procurement Crossfunctional procurement World class supply management
Focus of strategic sourcing
Figure 2.4: Evolution of procurement function Source: Keough, 1993.
18 As a procurement function evolves over time, the value-add of the function increases together with the strategic contribution of the function. What is, however, very important is that an organisation makes a deliberate choice in terms of the level at which it wants its procurement function to operate and then design the function accordingly. This decision will be driven by the nature of the organisation’s spend base, and the size of the spend as a percentage of revenue. An organisation with very little spend on goods and services may decide to focus on serving its operations on a less strategic level because the cost and effort involved in operating at such a higher level does not warrant the return on investment. The five stages in the journey to strategic sourcing as defined by Keough (1993: 2-3) can be described as follows: i) Serve the factory: This is the initial stage of procurement and the function’s main purpose is only to keep operations ongoing. The focus is clerical in nature and one of the key duties is that of expediting purchase orders; ii) Lowest unit cost: As procurement items increase in importance in an organisation’s cost structure, procurement’s responsibility grows in terms of minimising input costs. The focus is now on cost analysis, competitive bidding and negotiations; iii) Coordinated purchasing: As procurement items further increases in importance, there is more pressure to ensure lower costs, coordinated procurement activities across different business units and production sites take shape. This phase is the first step to leverage economies of scale in the procurement environment; iv) Cross-functional purchasing: The main difference between this stage and the previous is the realisation that design, specification and supplier development can have a far greater impact on the value released in the procurement process than negotiations alone. To be effective, the procurement function needs to re-organise itself and leverage the principles of crossfunctional team collaboration to extract optimal value. v) World-class supply management: The last stage recognised by Keough (1993) is that of world-class supplier management where the focus shifts to development of suppliers to become as effective and efficient as the organisation to reduce the total supply chain cost. If the total spend of the organisation represents a substantial portion of the turnover of that organisation, for example 50 per cent, it warrants procurement operating at a level between coordinated procurement and world-class supplier management. It is in circumstances like these that the strategic sourcing process is the most suitable procurement process and where it will deliver optimal value. Burt et al. (2003: 650) declare that strategic sourcing is the key element of a world-class supply chain function.
19 A practical model is that of TATA Steel (2004: 1). Very much based on the principle of Keough (1993: 1), it is more practical and based on the actual experience of TATA Steel since embarking on a strategic sourcing approach in 1999. According to TATA Steel (2004: 1) its procurement function was a very traditional transactiondriven function prior to 1999. Its procurement function limited its focus to price negotiation, with very little in-depth knowledge of the commodities it procured. Over the next few years TATA transformed its procurement function into a knowledge-based, value-adding, professional procurement organisation. TATA’s procurement evolution process is illustrated in Figure 2.5 below.
Integrated Procurement Knowledge based buying Transactional Organisation
• Total Cost of Ownership • Consolidate and leverage volume buy • Skills: Professional, Team building • Style: Cross-functional • Negotiation based buying • Prime motive: avoid stock outs • Skills: Commercial, follow up • Style: Individualistic • Win-win relationship • Value Creation • Co-location Facilities • Life time contracting • Skills: Interpersonal, coaching • Style: Collaborative working
Strategic Sourcing
Prior 1998
1999
2001
2004
Figure 2.5: Evolution of procurement at TATA Steel Source: TATA Steel, 2004: 1. An interesting observation on TATA’s successful transformation is how the concept of TCO was introduced, together with the principle of cross-functional team collaboration as the transactionfocused function transformed into a knowledge-based buying organisation. Thereafter, the function moved into an integrated procurement function, built on value creation and relationship management. When one compares the TATA experience with Keough’s (1993) model, the clear outcome is that TATA progressed into a level of cross-functional procurement, but that world-class supplier management has not been reached yet. In Chapter 3 the status of Sasol’s procurement function is similarly plotted on Keough’s model.
20 2.6 THE MEASUREMENT OF PROCUREMENT VALUE-ADD
The measurement of procurement’s performance is vitally important as procurement functions are playing an increasingly strategic role in many organisations according to Murray (2010: 1). These measures need to portray the procurement function’s efficiency and effectiveness where efficiency refers to the cost of the function and effectiveness to the value-add of the function. Carter (2010: 1) views a balanced scorecard approach as the most effective way of measuring a procurement function’s effectiveness and efficiency, as this approach reviews financial as well as non-financial measurements. This approach considers four perspectives namely: financial, customer, processes and learning. Lindstrom (2010: 1) also supports a balanced scorecard approach, as the key performance indicators (KPIs) assist an organisation’s management in monitoring progress against strategy execution, expected deliverables and the organisation’s maturity. Lindstrom (2010: 1-2) identified the following KPIs to be measured: i) ? ? ? ? ii) Financial Savings realised; Spend managed per employee; Savings generated per employee; and Sourcing strategy maturity. Customer
According to Lindstrom (2010: 2) it is critical for procurement to track customer satisfaction and engagement. A mechanism to conduct such measurements is the utilisation of customer satisfaction surveys. iii) Process
Most procurement functions focus on process improvements to increase efficiency. Cole (2006: 12) identified the following internal KPIs as important measurement indicators for internal processes: ? ? ? Number of new suppliers used; Number of new invoices processed against previous year; and Percentage of automated transactions.
Lindstrom (2010: 3) highlights that supplier performance has a major impact on the efficiency of a procurement function and suggests the following supplier measurement KPIs: ? ? ? ? On time delivery; Supplier rating; Supplier innovation; and Learning and growth.
21 Competent people are one of the critical success factors for a successful procurement function and it is therefore important to track employee skills and competencies for development purposes (Lindstrom, 2010: 3). 2.7 ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? KEY LEARNINGS Procurement is one of the nine generic functions in Porter’s Value Chain Model, which can create a competitive advantage in an organisation. Procurement is about the sourcing of goods and services at the right place, time and TCO and which are used to provide goods and services to customers. Strategic sourcing is a procurement process which can be employed by an organisation to extract value and thereby create a competitive advantage. The value released by a procurement function can directly be added to the EBIT of an organisation. In order to be able to add value, the procurement of goods and services must represent a substantial portion of the cost structure of an organisation. Procurement’s value contribution has increased significantly in South Africa due to an increased focus on the cost structures of organisations. TCO accounts for all direct and related costs of a commodity. Strategic sourcing’s intent is to reduce the TCO of a commodity. No proper sourcing decision can be made in the absence of a proper TCO model. A procurement function can operate at different levels. It is a purposeful, necessary and deliberate decision taken by an organisation to decide on the level of procurement at which it wants to operate. The higher the level of operation, the more important skills become. The higher the level of operation, the bigger the value-add. A balanced scorecard approach is an effective approach to tracking a procurement function’s performance. A balanced scorecard focuses on financial as well as non-financial indicators. Measurement of value-add becomes increasingly important as procurement’s importance grows. In Chapter 6 Sasol’s procurement scorecard is investigated and compared to the theory discussed above.
22 2.8 CONCLUSION
In Porter’s Value Chain Model (Business Policy, 2010: 2), procurement is one of the nine generic activities in an organisation which need to function collaboratively in order to create value to the customer. The extent to which an organisation is able to leverage effectiveness and efficiency of one of these generic activities will contribute substantially to the creation of a competitive advantage for the organisation. The procurement function can support this process by reducing and managing the input costs into the organisation’s operation. Procurement is defined as the sourcing of goods and services at the right place, time and TCO and strategic sourcing is a procurement process that has proven its ability to contribute substantial value-add within an organisation, as well as crafting a competitive advantage for the organisation. The value-add of a procurement function can be directly added to the EBIT of an organisation and in South Africa the focus on procurement as a value-adding partner has increased substantially over the last 20 years. The framework within which strategic sourcing adds value to the organisation is that of total cost of ownership (TCO). No proper sourcing strategy can be developed in the absence of a welldeveloped TCO model. The decision to embark on a process of strategic sourcing is however a deliberate management decision, and can not be implemented by default. Implementation and development of the strategic sourcing process in an organisation requires substantial investment in systems and skills, but such a decision can unlock intrinsic value in the organisation. The last important factor to consider is measurement of a procurement function’s effectiveness and efficiency from a strategic perspective, and for this action all evidence points towards a balanced scorecard being the most effective approach.
23
CHAPTER 3 CREATING A VALUE-ADDING PROCUREMENT FUNCTION THROUGH THE IMPLEMENTATION OF STRATEGIC SOURCING: THE SASOL CASE
3.1 INTRODUCTION
“When ability exceeds ambition, or ambition exceeds ability, the likelihood of success is limited” ~ Ralph Half. This chapter focuses on the way in which Sasol went about implementing strategic sourcing in order to elevate is procurement function to a world-class function, away from a traditional transactional role to a true value-adding strategic function. The intent is to examine to what extent the theory developed in Chapter 2 is aligned with the practical experience in Sasol. The research study investigates how the procurement function in Sasol evolved over time, the case for change and the value realised in the organisation. 3.2 THE CASE FOR CHANGE
According to Van Wyk (2010), the main drive behind Sasol’s decision to implement strategic sourcing in 1999 was the financial pressure the company was under at the time due to the oil price having dropped to around $10 per barrel. Against this background, the CEO at that stage, Mr Peter Cox, was looking at various alternative cost saving methods to help the company weather the storm, when the focus shifted to the procurement function. According to Du Preez (2010) Sasol tested the market for proposals by key consulting houses on alternative methods to reduce input cost. The results, according to Du Preez (2010), were originally not very positive as consultants pitched proposals of which the possible value extraction were in the order of R30 to R40 million. A consultancy firm which was quite new in South Africa at the time, McKinsey & Company, then proposed a process through which it believed a number of between R400 million and R800 million could be achieved by implementing strategic sourcing and applying the principles of TCO, as discussed in paragraph 2.4. As Van Wyk (2010) states, at that stage Iscor had embarked on this process and achieved very positive results. The R400 million to R800 million figure, was based on the estimated spend base in 1999 of around R8 billion and McKinsey projected a benefit of between five and ten per cent on the spend base (Sasol 2000: 6). The potential percentage benefit was based on McKinsey & Company’s benchmarked experience at the time. The organisation received the proposal with scepticism, especially due to the fact that the potential of R800 million that was put forward was, at that stage, more than the nett profit of Sasol (Van Wyk, 2010). Sasol’s management were very reluctant to believe that it was possible to extract value to such an amount, and after a review of the figures a final target was set: R400 million had to be realised over a three-year period. The original drive was to make Sasol more profitable and
24 not necessarily to re-engineer the procurement function and the concepts of TCO and strategic sourcing were rather unknown (Du Preez, 2010). According to Du Preez (2010) the procurement function was equally sceptical about the value proposition presented, but after engaging with McKinsey & Company, they realised that the TCO principles were multifaceted, and not quite as simple as only examining the price of a commodity. Slowly, the realisation started to manifest that such an extraordinary value proposition was indeed possible. This whole change process was facilitated through visits to Iscor Ltd (now Mittal Steel) and other overseas companies who had adopted the same methodology, to learn more about the approach and investigate best practices. According to Du Preez (2010) and Van Wyk (2010), obtaining buy-in was a long and demanding process and various presentations had to be made to the Sasol executive committee under the chairmanship of Mr Peter Cox. Buy-in and support for the process had to be obtained because implementation of the process required substantial investment to be made. An initial number of R20 million was indicated (Van Wyk; 2010), and the total investment over the next four years for training, acquiring the right skills in the organisation, process design and systems development was in the order of R100 million (Kritzinger; 2010). Considering the specific time period of tough economic conditions, requesting an investment of R20 million while unflinchingly trusting the process to deliver R400 million in value, was quite a bold request, and consequently, convincing the rest of the business after the approval process at the Sasol executive committee was yet another long and hard process during which each and every business unit in Sasol’s South African (SA) operations was visited for presentation of the new approach and its impact on each business unit. 3.3 PROJECT PHASE
After the Sasol executive committee approved the implementation of strategic sourcing, a formal project by the name of NetGain was launched to introduce strategic sourcing and principles of TCO to the organisation. The slogan of the project was: “There is always a better way.” (Sasol, 2000: 1) Project NetGain was about the following (Sasol, 2000: 3): ? ? ? Transformation of Sasol’s procurement function to be on the cutting edge of world-class standards on a continuous and sustainable basis. It is an essential catalyst and tool to bring about a meaningful change in the way the Sasol Group manages its materials and services. It functions by means of cross-functional and cross-divisional teams using an internationally established tool.
25 ? Its results improved the bottom line of each business unit in Sasol and therefore also Sasol’s bottom line. 3.3.1 Structure
The project was overseen by a steering committee under the chairmanship of the Group executive member who held the project team accountable for the set target of R400 million. The NetGain project operated by means of two structures namely: a temporary value team structure and a permanent strategic sourcing team structure. The temporary team was a crossfunctional, cross-divisional team that focused on building a TCO model for a specific commodity, and thereafter, through a process of supply market analysis, developed a sourcing strategy for that commodity. Part of the strategy development process included a list of quantified ideas on how to reduce the TCO of the commodity (Sasol, 2000: 3a). These actions were completed by the temporary teams during a twelve-week period, where after the results were handed over to a newly-established permanent structure called the sourcing team, responsible for implementation of the results attained by the value team and management of the commodity on a continuous basis. The principle behind the two structures is explained in Figure 3.1.
Continuous process of value creation by Strategic Sourcing Team Develop Track sourcing performance strategies and set targets
Value Team analysis
Handover to strategic sourcing team
14 week temporary team
Develop TCO model Set savings targets Identify opportunities Develop saving strategy plan implementation
Implement ideas
Identify Opportunities
Figure 3.1: Comparison between value team and strategic sourcing teams Source: Adapted from Sasol 2001: 7.
26 The reasoning behind this approach was the fact that Sasol was, at that stage, organised in silos. Van Wyk (2010) refers to three silos namely: i) ii) iii) Maintenance; Production; and The functional environment of which procurement was one.
Each silo had its own goals and performance criteria and was performing in terms of its own performance metrics without considering the actions of itself or each other, and in doing so actually working against each other in some cases. To accomplish the development of proper sourcing strategies for commodities, the inputs of all concerned stakeholders are required and commodities therefore have to be analysed from a crossfunctional, cross-divisional perspective. It was for this reason, according to Van Wyk (2010), that they started the process with value teams, of which the members were elected from different environments specifically to bring into effect the principle of following a cross-functional, crossdivisional approach. Du Preez (2010) highlights that the people who served on the value teams, as well as the members of the permanent strategic sourcing team structure, form part of a “thinking structure”. You are required to think outside the box, and you need to apply that frame of mind company wide and in many cases, globally. 3.3.2 Identifying the key commodities to focus on
When the process was initiated there was no accurate spot data, and the organisation had little acumen for what exactly was spent on the various commodities (Van Wyk; 2010). With this scenario, against the background of a spend portfolio of over R8 billion in 2000 and the help of McKinsey & Company, the project team started out by building a comprehensive spend base to understand what Sasol spend on the various commodities it procured, with whom they spend and what was actually bought. Thereafter, as Du Preez (2010) calls it, they integrated the spend base and applied the 80/20 principle to determine which commodities to focus on. This decision was based on spend value, and strategic importance of a commodity and the team worked according to the assumption that the commodities with the highest spend would yield the best return. About 100 commodities were identified to focus on, and the value teams were established and organised into waves to address these commodities, a process that was completed by 2005. Van Wyk (2010) explains that the process of building a spend base and identifying the key commodities was extremely difficult due to the fact that there was no standardisation in the Group and different business units procured the same commodities, but with varying descriptions, from the same suppliers in many cases. On a consolidated basis, Sasol could not aggregate this spend and thereby leverage the economies of skill and scale. It required investment in a process of
27 standardising the descriptions of the commodities that were bought and as a solution, they opted for the United Nations Standard Products and Services Code (UNSPC) naming convention (Van Wyk, 2010). 3.3.3 The value team process
The value team process was a standard 14-week process, followed for each of the identified commodities. The process consisted of four distinct phases namely: i) ii) iii) iv) Building a fact base and setting of targets; Development of strategy and ideas; Implementation; Handover to strategic sourcing team.
The process is illustrated in Figure 3.2. The value team process, and each of the phases are thereafter discussed in detail. The value team process forms the basis of the strategic sourcing process to this day.
Build the fact base and set targets
Develop ideas and strategy
Initiate implementation
Handover
Weeks 1 – 2 Develop a team plan Review previous/ ongoing efforts, baseline spend, and inventory Calculate TCO and understand TCO levers Understand the supply market Finalise team targets
Weeks 3 – 7 Hold stakeholder workshop Generate TCO savings ideas Evaluate TCO savings ideas Develop commodity strategy Send out requests for proposal (RFPs)
Weeks 4 – 12 Set up draft action plans Soundboard & refine action plans with stakeholders Get sign-offs from stakeholders Implement quick wins Develop tracking tools Manage ideas in the NetGain Idea System
Weeks 10 – 12 Set up generic action plans for ideas not pursued yet Soundboard generic action plans with stakeholders Transfer ideas individually to new commodity team Prepare sign-over documents Hold formal sign-over meeting
Figure 3.2: Sasol value team process Source: Sasol, 2000: 6d.
28 i) Building the fact base and setting of targets
This phase consists of the gathering of data across the various Sasol business units in order to understand the spend patterns of the business and the various specifications between the different business units. The analytical tools that are used are detail spend and inventory analysis, supplier economics, industry cost curve analysis and the TCO model (Sasol 2001: 25). A key deliverable during this phase is the TCO model (which is discussed in more detail in Chapter 4). The developed TCO model is used as the baseline TCO for the commodity against which all future improvements are measured. At the end of this phase, the team has a good understanding of the supply market, as well as the internal usage and requirements of the end users. During this phase the team members mostly engaged intensively with all stakeholders, but with specific focus on end users, to obtain the necessary information (Sasol, 2001: 25). ii) Develop ideas and sourcing strategies
This is a very critical phase in the process, for it is during this phase that a sourcing strategy is developed and the team performs a rigorous process of generating ideas to reduce the TCO of the commodity. The ideas are obtained by involving key end users, industry experts, suppliers and other stakeholders (Sasol 2001: 31). Various methods are employed to generate ideas and the team facilitator plays a critical role here. According to McKinsey & Company (Sasol, 2001: 34), five per cent of all ideas are commercial, 20 per cent are provided by end users mostly based on consumption and 10 per cent of all ideas are provided by suppliers. Suppliers are usually in a good position to assist in identifying the correct material specifications. The ideas are then quantified and together with the information gathered in phase one, a proper sourcing strategy is developed and presented to the project steering committee for approval. Sasol learned the importance of end user support very early in the process, and therefore all ideas were presented to the end users as well for agreement and sign-off (Du Preez, 2010). Another deliverable during this phase is the issuing of a request for proposal (RFP) to the market in order to obtain more ideas and inputs into the sourcing strategy. iii) Initiate implementation
The next phase is focused on the development of a detailed action and implementation plan, and the finalisation of all the ideas to be implemented. Quick wins are implemented immediately and the key performance indicators (KPIs) are defined (Sasol, 2001: 82).
29 iv) The handover
The final stage is the handover of the sourcing plan together with the detailed fact pack to the strategic sourcing team who now takes full ownership of the set targets and whose performance is measured against those targets. The whole process is driven by a continuous process of stakeholder involvement and communication of further ideas to stakeholders. All of the above takes place within an ethical framework which is captured in the cardinal rules of Sasol’s procurement practice (Sasol, 2001: 75). ? Sasol conducts all business in accordance with its mission:
“Sasol believes in the free enterprise system … and we insist on the highest ethical standards … and will not tolerate or condone illegal acts of employees.” ? ? ? ? ? ? 3.4 Procurement & Supply have co-responsibility for ensuring adherence to the Sasol rules. Sasol technology and business transactions are confidential and should not be divulged to third parties. Different departments should be involved to ensure adequate cross controls. All forms of dishonesty such as bribery, over-invoicing, fraud, embezzlement will be handed over to the police for investigation. All Sasol agents have to comply with all commercial rules and practices. If in doubt, do not improvise, but discuss. POST-PROJECT PHASE
One of the biggest mistakes, according to Kritzinger (2010), many organisations make when implementing strategic sourcing, is that they see it as a project with a start and end date. They conclude a diagnostic phase and set targets for value to be released, but as soon as that value has been realised the initiative comes to an end and the function starts to move back into its historical role of being only a service function. As a result, the value that has been released erodes as sustaining of the value is as complex as it was at first to realise it. Important to remember is that this is a process of continuous improvement which is only kickstarted with a project phase (Van Wyk, 2010). As soon as the project is complete, new business processes must be entrenched and senior management must continue to hold the function accountable for a continuous stream of new value-add (Kritzinger, 2010). To ensure such an outcome, Sasol had intentionally decided to discontinue the use of the word NetGain after completion of the NetGain project phase and established a formal strategic sourcing structure to which the project results were handed over, and which became responsible for further improvement. This structure is still managed and annually measured against set targets in terms of a set of key performance indicators which are discussed in Chapter 6 (Kritzinger, 2010).
30 The current structure consists of nine strategic sourcing teams addressing 55 per cent of the total Sasol SA spend, and a set target to increase its spend management portfolio to 75 per cent by 2012 (Du Toit, 2010b: 17). Formal governance has also been put in place to govern the business processes as well as the measurement of the value released, which is audited on an annual basis (Sasol, 2010a) and (Sasol, 2010b). 3.4.1 Transformation of the procurement function
In Chapter 2, paragraph 2.5 the transformation of a procurement function was discussed in great detail. According to Keough (1993) there are various stages of evolution of the procurement function. The purpose of this section is to explore the way in which the procurement function in Sasol evolved over the last ten years. Van Wyk (2010) explained that the procurement function in Sasol had the following characteristics before the process to implement strategic sourcing was started, namely: ? ? ? ? ? Decentralised, with no aggregation of spend; No real knowledge of how much was spent; No leverage of economies of skill and scale; No value proposition; No strategic focus or agenda.
Du Toit (2010a) describes the environment as a typical three-bids-and-a-buy environment where the procurement function basically only executed tasks in accordance with the needs of the end users. Now, when comparing these characteristics with Keough’s (1993: 1) model, it typically places Sasol between a service to the factory, and lowest unit cost focused type of procurement function around 2000. The model further indicates that the true value-add to the organisation is very low with this type of approach and thus very little value is added.
31
Stages of evolution High Value-add Low Focus Keep plant running Minimise cost Lower cost by leveraging economies of scale Specification resign supplier development Strategic supplier selection Serve the factory Lowest unit cost Co-ordinated procurement Cross-function procurement World-class supply measurement
Sasol’s position
1999
2010
Figure 3.3: Evolution of Sasol’s procurement function Source: Adapted from Keough, 1993: 2. As illustrated in Figure 3.3, Sasol can today be plotted on the brink between cross-function procurement and world-class supply management as described by Keough (1993). Kritzinger (2010) describes how there is a strong focus on specific key strategic commodities in Sasol today, and strategic sourcing teams are continuously looking at new ideas such as challenging of specifications and supplier development. The process of strategic supplier selection is not yet wellentrenched despite small pieces of evidence to excellent results in areas where it has been applied in Sasol. Thus, as from the time of making the decision to embark on the strategic sourcing journey, up to today, the procurement function in Sasol were able to elevate its value-adding contribution from a mere service department to a value-adding business partner which is very much in line with the model of Keough (1993) in the early 1990s and which is proven to still be relevant today. What Keough (1993) was not able to describe, is the journey of an organisation to enable it to move up this curve and it is for this reason that the Sasol case study has such high value. 3.4.2 The current procurement environment in Sasol
Since the inception of strategic sourcing in 1999, Sasol was able to establish a sustained, highly skilled strategic sourcing structure. The procurement landscape has drastically changed since then due to mergers and organic growth of the organisation. Sasol’s total spend today, is illustrated in Figure 3.4 and the spend accounts for more that 54 per cent of turnover which makes procurement the second most important lever in Sasol to improve productivity as described in Table 2.1. With a spend base of R74 billion, Sasol is also under the top five procurement functions of its size in South Africa (Kritzinger, 2010).
32
137,836 30,911
16,643 4,558 3,611
7,804 74,309 12,577 1,342 558 59,832
TURNOVER AS PER GROUP INCOME STATEMENT
EBITDA
INTERNAL LABOUR
NON-PROC ITEMS*
FUEL SWAPS
COST OF STOCK
TOTAL SPEND FY09
CRUDE OIL
FUEL IMPORTS
EXTERNAL COAL PURCHASES
EXTERNAL SPEND FY09
Figure 3.4: Sasol total spend on goods and services 2009 Source: Du Toit, 2010b. Figure 3.4 illustrates the total spend as derived from Sasol’s financial statement. The reason for ring-fencing crude oil and fuel imports, is the absolute magnitude of spend in this particular area and the strategic importance thereof. This commodity is managed on the principles of strategic sourcing and the concept of TCO, which is illustrated in Chapter 4 by using crude oil as an example. The R74 billion includes Sasol’s global spend and the South African portion of the spend, but excludes crude oil for 2009 which was R23 billion (Du Toit, 2010b: 18). Du Toit (2010a) further describes how one of the key measurements to track the performance of the strategic sourcing process on an annual basis, is to analyse the annual movement in spend and to observe the effect of activity changes, market changes and strategic sourcing improvements thereon. Figure 3.5 illustrates this measurement for 2009 as well as the contribution of strategic sourcing compared to 2008. As per the annotation, the total spend in 2008 was R18 billion. The effect of a decrease in activity on spend on goods and services was R1.1 billion, and was mainly due to the economic crisis while the market inflation on the basket of commodities procured by Sasol had a R2.7 billion negative effect on the spend base. This is calculated based on the movement in all the market indices which have an effect on the Sasol spend base. The actual calculation is discussed in Chapter 4. The effect provides for an adjusted baseline for 2008 of R20 billion.
33
4,002 20,175 (644)
23534
2,667 2,095 2135 14,811 (86) 17,032 (514) 18,613 (1,104)
Total spend FY07
Activity adj: (0.6% )
Market adj: 14.33%
Adjusted Baseline
TCOR FY08
Increase / Decrease
Total Spend FY08
Activity adj: (5.9)%
Market adj: 15.23%
Adjusted Baseline
TCOR FY09
Increase / Decrease
Total Spend FY09
Figure 3.5: Movement in spend for Sasol South Africa Source: Du Toit 2010b: 17. The strategic sourcing contribution for the year was R0.64 billion but there is still an additional increase of R4 billion. One of the effects of having a strategic procurement focus, and part of the function’s value proposition, is the ability to explain movements and changes in the spend base to senior management. According to Du Toit (2010a), the R4 billion increase can be explained as follows: R2 billion was due to a new plant which came into operation and R2 billion was due to abnormal maintenance. 3.5 VALUE ADDED BY STRATEGIC SOURCING IN SASOL
According to Kritzinger (2010) more than R3.8 billion in value has been released by the strategic sourcing process in Sasol since 2000. The annual contribution, as reported by the teams, is shown in Figure 3.6. These numbers are audited on an annual basis, and all teams are held accountable for accurate tracking and reporting of the numbers as well as the sustainability of these numbers (Swanepoel, 2010).
34
645
3,883
513
372 232 388 382 483 389 378 103
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
Total
Figure 3.6: Value released by strategic sourcing 2000 to 2009 Source: Bornman, 2010b. What is interesting to note, is the consistently growing contributions when compared on an annual basis. Also, when you compare this data with the initial forecast by McKinsey of R400 million, one sees that the average contribution over the ten years is R388 million per annum, which is very close to the R400 million originally forecasted. Besides the fact that this is a major contribution to the organisation, these numbers also prove the aspect of sustained continuous improvement. If strategic sourcing was treated only as a project, the project would have achieved its goals in 2001/2002 and the rest of the value-add would have been lost to the organisation. This brings us to the important aspect of “how” to measure this value release. Sasol spent a great deal of time on the development of a set of ground rules which explicitly prescribes the way in which to measure this value. Chapter 4 and 5 focus on how to measure the value released. 3.6 ? ? ? ? KEY LEARNINGS The potential benefit after implementation of strategic sourcing is between five and ten per cent of total spend. Change management is a major element for success. The company needs a burning platform to launch this initiative. The company must invest in skills development, technology support and business process development.
35 ? ? ? ? ? ? ? ? ? ? ? ? ? ? 3.7 When implementing strategic sourcing, a duel structure helps to create the inputs required to get the process going. A formal project needs to be launched – this is not business as usual. Identifying the key commodities may be a difficult process – do not expect that the spend pattern is known. End users, suppliers and procurement’s commitments are critical to the success of the process. Do not see strategic sourcing as a project, but as a new business process. It is not a quick fix, but a long-term commitment. Senior management’s constant commitment is a crucial requirement. Formal governance for the process must be put into place. Procurement is the custodian of the spend base on goods and services. Procurement needs to understand the effect of activity and market changes on the spend base. Strategic sourcing needs to be able to prove its value-add in terms of total spend. Procurement needs to analyse and explain the effect on spend in terms of other strategic decisions made by the organisation. Strategic sourcing is a continuous improvement process. Strategic sourcing can add a substantial amount of value to an organisation over time. CONCLUSION
When an organisation decides to embark on a process of implementing strategic sourcing, a potential benefit of between five and ten per cent of value released from the total spend base is possible. This is, however, not an easy process to implement and the Sasol case study suggests that the best way to approach such an implementation, is to start with a formal project, based on a sound business case. For the project to be a success, the organisation definitely needs to attain its best available skills, and secure senior management support for the project. Due to the wide reach of the process, change management is of absolute importance because this is a process that breaks down silos within an organisation, and completely transforms the traditional approach to procurement in order to extract the optimal value from a total cost of ownership perspective. The project must focus on key commodities in order to extract the optimal value and a formal process needs to be followed by a dedicated team to identify the key commodities to focus on. Yet it is important that the project phase comes to an end and that the new process becomes an official and embedded business process in the organisation to derive a sustained and continuous stream of value to the organisation.
36 The Sasol case study has also proved the theory of Keough (1993: 1-8) in terms of the different stages of evolution of a procurement function and the true value that an organisation can expect depending on the stage that it is operating in. To sustain this value is very important, and Sasol has showed that a formal governance process needs to support a strategic sourcing process to ensure success. The value released by the process is significant, which also supports the view of Chapman et al. (1997: 32) that the purchasing of goods and services is the second most important lever, by which an organisation can extract value and improve its bottom line. The Sasol case has proven this value of procurement, but it also proved that the measurement of the value unlocked through the process is no easy task. The next two chapters focus on this aspect of the process.
37
CHAPTER 4 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: TOTAL COST OF OWNERSHIP MODEL
4.1 INTRODUCTION
“To measure is to know” and “when you can measure what you are speaking about, and can express it in numbers, you know something about it; but if you cannot express it in numbers, then your knowledge is of meagre and unsatisfactory kind.” Lord Kelvin 18th Century (De Souza, 2007). Three centuries later, the case of measuring the value creation of strategic sourcing in an organisation is just as important as measurement was to Lord Kelvin. Measurement of value released, lays the foundation to ensure that the value-add promised in the business case to request the substantial investments required to make implementation of strategic sourcing a reality, is indeed realised. If not, corrective action can be taken, but it needs to be done timeously. Measurement is also critical to ensure that the value released is sustained over time and that unnecessary and eliminated costs do not creep back into the cost structure of an organisation (Van Wyk, 2010). When Sasol decided to implement strategic sourcing in 1999, it was during a time when global commodity prices were severely depressed (Van Wyk, 2010) and the organisation was forced into a situation where it needed to focus on its cost structure, as spend on goods and services accounted for more than 60 per cent of its turnover and it was critical to focus on input costs. Senior management engaged with McKinsey & Co. to implement strategic sourcing as the vehicle to focus on input cost. A project called NetGain was launched to implement strategic sourcing throughout the Sasol Group with the goal to extract R400 million in value. There was quite some scepticism about the promise to extract R400 million as various other consultants at that stage indicated that the potential value release would be in the region of R35 million. It was thus very important to the Sasol Board that the actual value released had to be tracked, measured and reported on a continuous basis. At a later stage it also became important to ensure that the value released was sustained, and where leakages occurred, those leakages were captured and corrective action was taken (Swanepoel, 2010). The key question was, however, how do you track the value created by strategic sourcing by applying the TCO principle?
38 4.2 TOTAL COST OF OWNERSHIP AS BASIS FOR MEASUREMENT
As already explained in Chapter 2, the TCO of a commodity consists of all the costs directly and indirectly associated with that commodity. Sasol decided to adopt this approach of strategic sourcing. The R400 million target for value release was based on the reduction of TCO of the various commodities procured by Sasol. As to how the actual measurement of this value release was to be done, however, was unknown, and no guidelines were available at that stage which meant that Sasol had to create its own set of rules and measurement methodology to measure the value released (Du Preez, 2010). In Sasol, the TCO of a commodity is summarised in four buckets namely: direct cost + internal cost + related cost + opportunity cost related to the commodity in question. This is illustrated in Figure 4.1.
12 0
5 10 0 5 80 80 10
10 0
60
40
20
0 D i r e c t C o st I ndi r e c t C o st R e l a t e d C ost Op por t uni t y C ost TC O Ye a r 1
Figure 4.1: The TCO cost buckets Source: Sasol, 2004: 36. These cost buckets, represent the grouping of the various TCO cost elements into the four main buckets. The four cost buckets can be described as follows Sasol (2004: 37): i) Direct cost bucket
This bucket represents the initial purchase or lease cost which is determined by multiplying the purchase price by the annual volumes purchased. In order to calculate the direct cost it is important to have accurate purchase data and administrative records.
39 ii) Related cost bucket
These are the costs of associated items and activities which are necessary when making use of a specific commodity. Examples include certain maintenance contracts from suppliers, spare systems, spare parts, specialist contractors and even unique packaging that is required. iii) Internal cost bucket
These are the costs that a company needs to incur in order to own a commodity. This is typical the labour cost of people who maintain or install the commodity purchased. iv) Opportunity cost bucket
These costs refer to costs associated with the cost of an opportunity due to the commodity not performing or not being available. The decision to implement the TCO approach of strategic sourcing means that value can be released by focusing on all four cost buckets, and in so doing, reduce the input cost of Sasol. The principle point of departure is, if one adds the TCO of all commodities procured by an organisation, together with the exception of the opportunity bucket and labour cost, it will add up to the total spend of an organisation less labour (Crafford, 2003: 2). This principle can be explained as follows: TCO1 = Direct Cost1 + Related Cost1 + Internal cost1 + Opportunity Cost1 TCO2 = Direct Cost2 + Related Cost2 + Internal Cost2 + Opportunity Cost2 TCO3 = Direct Cost3 + Related Cost3 + Internal Cost3 + Opportunity Cost3 TCOn = Direct Costn + Related Costn + Internal Costn + Opportunity Costn = Total Direct Cost + Total Related Cost + Total Internal Cost
= Total Cost of Goods and Services + Labour Elements
Figure 4.2: TCO vs. Total cost of goods and services For Sasol, it was decided that, to reduce the TCO of a commodity on an annual basis, would be the simplest form of value release in terms of strategic sourcing to implement.
40
12 0
10 0 10 0
20
80 80
60
40
20
0 TCO Ye a r 1 Be ne f i t s TCO Ye a r 2
Figure 4.3: Year-on-year TCO reduction In Figure 4.3 above, the value released year-on-year is illustrated as 20 units. In Sasol, this is referred to as benefits (Bornman, 2010a) and is reported to the Sasol Board as such. However, significant procurement inefficiencies may go undetected if only the nominal amounts expended are compared year-on-year and the reverse is also true. While strategic sourcing may be generating extensive value on the one hand, its performance may be overshadowed by an increase in volumes purchased as a result of growth in the organisation or due to movements in macro-economic factors such as inflation and exchange rates. So in order to obtain a more accurate view of the strategic sourcing performance, according to Joubert, Kritzinger and Crafford (2004: 2), the nominal year-on-year TCO baseline value must be adjusted to neutralise the effect of variables such as: ? ? Activity changes as a result of factors such as growth (capital projects) or activity decreases (plants closing down); Changes in macro-economic factors such as inflation, exchange rates and relevant commodity prices such as steel prices and crude oil prices. The extent, to which the nominal expenditure is adjusted to determine a comparable baseline for a particular year, should be carefully scrutinised and must be subject to governance. The formal governance of the process is critical to the integrity of the value reported as well as the integrity of the strategic sourcing process as a whole (Swanepoel, 2010). In the case of Sasol, these rules are formally governed by official governance procedure on the subject namely Procedure 001: Ground Rules For Benefits Calculation, as approved in December 2009 (Sasol, 2010a).
41 The adjustment of the TCO is explained in Figure 4.4, which illustrates how the baseline is adjusted to make provision for changes in activity levels and market environment changes.
12 0
10 0 10 0
2
3
1
96
16
80 80
60
40
20
0 T C O Ye a r 1 Market A d j u st m e n t Act ivit y A d j u st m e n t New P r oduc t i on C a pa c i t y A d j u st e d B a se l i n e Be ne f i t s T C O Ye a r 2
Figure 4.4: TCO baseline adjustment Source: Adapted from Joubert et al., 2004: 3. When the hypothetical example illustrated in Figure 4.3 and 4.4 is considered, one sees how the actual value released, which is referred to as benefits, decreased from 20 units in Figure 4.3 to 16 units in Figure 4.4, after making provision for market and activity adjustments. The adjustment of the TCO baseline is now analysed in greater detail as this forms such an integral part of the measurement process. 4.3 TOTAL COST OF OWNERSHIP BASELINE ADJUSTMENT
As already explained, there are three types of adjustments to the baseline which are now discussed in detail. 4.3.1 Market adjustment
The escalation or de-escalation from the actual procurement expenditure to determine the baseline for a given year, other than activity changes, is determined by factors influencing the price of goods and services procured. Escalation/de-escalation of indices are based on recognised official indices, based on an official published index of independent organisations such as Statistics South Africa or Steel and Engineering Industries Federation of South Africa (SEIFSA) (Joubert et al., 2004: 3).
42 This is considered to be the most important adjustment in Sasol and is again governed by a formal governance procedure by the name of Procedure 002: TCO price adjustment as approved in December 2009 (Sasol, 2010a). Sasol further established a dedicated Centre of Excellence for commodity indices, which is responsible for updating and compiling the commodity indices for TCO adjustment and benefits trading. According to Du Toit (2010a) who heads this Centre of Excellence, there are more than 250 commodity indices in the Sasol Procurement Index Model which is used for benefits calculation. A commodity index can be defined as an independent index that neither Sasol, nor the supplier has any control over. It has to be published independently and everybody has the right to access it (Du Toit, 2010a). In order to develop an appropriate independent index for a specific commodity TCO, one needs to determine the relevant cost drivers of that commodity, then establish the applicable importance of each cost driver and then find an independently published index in terms of each cost driver (Du Toit, 2010a). Finding the correct index can be a challenge, especially where there is an imported component to a commodity. In such a case, one will have to look at international indices as well as take into account the exchange rate (Du Toit, 2010a). The calculation of this index is independently done by the Centre of Excellence in Sasol in order to ensure that proper governance is applied and that a strategic sourcing team does not manipulate indices in its favour in order to report more benefits. According to Du Toit (2010a), the establishment of these principles can be regarded as a best practice since many companies, to this day, still measure the success of procurement’s effort on the principle of a three quote system where the difference between the highest quote and final paid price is regarded as the value released by the procurement department. Other companies, such as Sasol before the implementation of strategic sourcing, measured procurement activities against the general producer price index (PPI) and where annual price increases were below PPI, the difference was deemed to be a benefit. In Figure 4.5 below, it is illustrated how the PPI differ from the true movement in a market (based on the market variables that influence the commodity of electrical motors in Sasol).
43
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0% Jul 03 / Jun 04 Jul 04 / Jun 05 Jul 05 / Jun 06 Jul 06 / Jun 07 Commodity Jul 07 / Jun 08 Jul 08 / Jun 09
PPI: Domestic output - All groups
Figure 4.5: PPI movement vs. relevant commodity index for electrical motors in Sasol Source: Sasol, 2010c. As illustrated in Figure 4.5, it is clear that where a strategic sourcing team had negotiated the price increase for the period July 08/June 09 to be ten per cent, and the team was measured against PPI, the team would have been penalised as the PPI would only allow for an increase of nine per cent. In actual fact, however, the true index for electrical motors reflects an increase in the market of more than 12 per cent and in terms of the Sasol model, the team’s negotiated ten per cent increase compared to the 12 per cent market increase, assured a two per cent benefit for the organisation. One may very well at this point ask how is an independent index calculated then?
44 By applying the methodology used in Sasol, as explained by Du Toit (2010a), the following model can be developed to illustrate the process: ? ? ? ? Analyse the TCO Model; Determine the relevant cost elements for each of the buckets; Determine the appropriate indices which are weighted according to importance; and Calculate the independent index.
The process of developing an independent commodity index can best be described by the following four steps followed by Sasol:
Step 1 Analyse TCO Model Step 2 Determine cost element per bucket Deliverable Cost elements per bucket Origin of cost element Step 3 Determine relevant published index per cost element Deliverable Published index per cost element Step 4 Calculate Independent Index Deliverable Weighted commodity index for commodity
Deliverable Cost Buckets
Figure 4.6: Developing an independent commodity index By applying the four-step model as developed in terms of Sasol’s experience, the independent market index as developed for electrical motors is used below as an example.
45
Step 1 TCO model for electrical motors Step 2 Cost elements per bucket Step 3 Independent index per cost element
Purchase R107 767
35% Imported Material 15% Local Material 40% Labour
+
5% Transport 5% Overheads
R/$ x US Industrial PPI – All commodities Seifsa table G: Electrical engineering Materials Seifsa Table C3: index of actual labour cost All hourly-paid employees Wholesale prices of diesel: 0.05% Sulphur Gauteng PPI: Domestic output – All groups
Total TCO R188 067
Internal labour R 78 300
100% Labour Table C3: SEIFSA index of actual labour cost: All hourly-paid employees
+
Internal transport R2000 100% Transport Wholesale prices of Diesel: 0.05% Sulphur-Gauteng
Step 4 Calculate the new independent Index formula TCO Elements 57.3% Purchase 41.6% Internal Labour 1.1% Internal Transport 100% Index = 57.3% (35% Imp Material + 15% Local Material + 40% Labour + 5% Overheads) + 41.6% (100% Labour) + 1.1% (100% Transport) Index = 20.1% Imp Material + 8.6% Local Material + 22.9% Labour + 2.9% Transport + 2.9% Overheads + 41.6% Labour + 1.1% Transport Index = 20.1% x [R/$ x US PPI] + 8.6% x Table G + 64.6% x Table C3 + 3.9% x Diesel price + 2.9% x PPI: all groups
Figure 4.7: Development of an independent commodity index for electrical motors in Sasol Source: Adapted from Sasol, 2010c.
46 The independent commodity index does nonetheless have certain shortcomings when used in practice. According to Du Toit (2010a) she has experienced three common issues, namely: i) ii) iii) i) Time lag effect of an index; Finding the right index for a specific cost item; Changes in the structure of the index. Time lags
This is typical in the case of labour increases where labour negotiations take place around July, but the SEIFSA labour index only reflects the new labour rates around October/November. The same applies to the Road Transport index, which also usually lags with two to three months. This means that a TCO will reflect the new cost structure, but because the market index only reflects its adjustment later, the benefits reported will be understated when a market increase had occurred for example. ii) Finding the right index
It is a challenge, and sometimes impossible, to find the right and specific index, that reflects the true market movements 100 per cent correctly. The result thereof, is that you will inevitably end up with either a small over- or under statement of your results in specific cases. iii) Changes in the structure of the index
From time to time, the basket for the calculation of the index changes and this is not always known upfront and will also lead to incorrect measurement. As already mentioned, there is a strict governance process around the development of a commodity index and this can not be adjusted by a strategic sourcing team as preferred and beneficial to the team. In cases where there is a structural change within the commodity, the Centre of Excellence will, through the application of the four steps described, establish a new independent index (Du Toit, 2010a). 4.3.2 Activity adjustment
In order to manage and make value-adding decisions, the commodity TCO model must be measured in relation to the product output of the business (Sasol; 2004: 116). Excluding this productivity ratio from the TCO calculation, distorts the quantification of benefits. The activity level must be the most relevant and highest correlation to a commodity or service. It must constantly take into account and incorporate all production and environmental changes that are experienced in the business. It is, however, quite difficult to establish the appropriate activity measure, as the usage of all commodities is not necessarily directly correlated with the output of a plant, or the number of people working in an organisation (Swanepoel, 2010). In these cases it may be better not to make provision for changes in activity and measure only on a nominal year-on-year basis. One may then
47 encounter abnormal activity compared to the baseline year, but it may be better than to have to consider a once-off baseline adjustment. A practical example of such an instance could be abnormal maintenance that takes place every five years or where major equipment replacements take place. In such instances the intent is to ring fence these abnormal expenditures and remove it from the baseline (Swanepoel, 2010). 4.4 APPLICATION OF THE TCO MODEL AS A MEASUREMENT TOOL FOR THE VALUE CREATED BY STRATEGIC SOURCING: CRUDE OIL The application of the TCO model, as a way by which the value released through strategic sourcing can be measured, is best illustrated through the actual application of the principles described in the first part of this chapter, to crude oil as a commodity in Sasol. Crude oil is the single largest valued commodity procured by Sasol and sourcing of crude oil on the principles of strategic sourcing is governed by a Crude Oil Steering Committee. One of the agenda points of the Steering Committee is the actual performance of strategic sourcing as measured in terms of the TCO Model. For purposes of illustrating the TCO model, this research study looks at the comparison between the six-month periods July to December 2008, to July to December 2009, as reported to the Sasol Crude Oil Steering Committee in May 2010. 4.4.1 Elements of the Crude Oil TCO model
The elements of the Sasol Crude Oil TCO model, was derived from the life cycle of the crude oil purchasing process, with the following key elements: Purchasing, Shipping, Storage in Durban, Piping and Storage at Plant (Van Niekerk & Sefoka, 2010: 2). The key elements of the purchasing process, together with the cost drivers per element are illustrated in Figure 4.7 below. These cost elements are then quantified, which adds up to the TCO of crude oil. In the case of crude oil, due to sufficient buffer capacity at the Sasol refinery called Natref, there is no provision for opportunity cost in the TCO model.
48
Purchase of Crude Oil
Shipping of Crude Oil to South Africa
Storage in Durban
Pipeline cost to refinery
Refinery cost
Cost Elements
•Purchase Price •Letter of credit cost
•Insurance •Freight Cost •Surveying cost •Clearing and … •Cargo dues •Shipping agents commission •Demarcage
•Cargo Due •NATCOS
•Pipeline cost
•Storage •Refining
Figure 4.8: Purchasing life cycle cost elements for crude oil Source: Van Niekerk and Sefoka, 2010: 7. From the cost elements described in Figure 4.8 above, the TCO model below (Figure 4.9) in millions of US$ was derived.
1000 900 827.41 800 700 600 500 400 300 200 100 0 NATCOS Capital Costs on Inv Clearing Costs Piping Costs Insurance Cargo Dues Demurrage Other Total Purchase TCO FY 09 Freight 20.13 17.94 0.39 0 3.09 0.48 2.03 2.41 3.28 877.16
Figure 4.9: TCO of crude oil in Sasol July to December 2008 Source: Van Niekerk and Sefoka, 2010: 7.
49 The different cost elements of the TCO for crude oil are described in Table 4.1 Table 4.1: Cost elements of Crude Oil TCO model
Cost element Total purchase Freight Insurance Clearing costs Demurrage Cargo dues NATCOS Capital costs in Inv. Piping costs Other Related costs Description The sum of all purchases for the 6 months The cost of ocean freight from the port of loading to Port of Durban The cost of insurance on the cargo Costs incurred in clearing the cargo through customs Costs associated with standing time and delays of ships Cost paid to the ports authority for cargo movement within the port The cost (fixed and variable) of handling crude at NATCOS The cost of carrying crude inventory The cost of piping the crude from Durban to Natref, Sasolburg. Smaller costs aggregated to ease of reference e.g. was risk, tug charges, surveying and piracy deviation The cost of taking future position and other smaller finance costs, guarantee fees, interest, etc.
Source: Van Niekerk and Sefoka, 2010: 8. 4.4.2 Activity adjustment
For the purpose of activity adjustment, the actual Natref production output is used. For the period under investigation, this revealed that the production had increased by 3.3 per cent (Van Niekerk & Sefoka, 2010: 6). This means the TCO of the first six-month period will be adjusted upward by 3.3 per cent. In other words, the TCO of US$877.2 million as per Figure 4.9 would increase by 3.3 per cent to US$905.7 million. 4.4.3 Market adjustment
For the market adjustment, Sasol uses the Brent Oil prices (Van Niekerk & Sefoka, 2010: 8). The index was constructed using the Brent Oil prices with July 2007 as a base, as published on the Sasol Commodity Indices Model. Each subsequent price is divided by the base price and the quotient is the index. The average indices for each six-month period are compared to determine the direction of prices in the two periods. The indication was that crude oil prices fell by 15 per cent between the two periods as is illustrated in Table 4.2.
50 Table 4.2: Percentage change in crude oil price with July 2007 as base
Period July 2008 August 2008 September 2008 October 2008 November 2008 December 2008 January 2009 February 2009 March 2009 April 2009 May 2009 June 2009 July 2009 August 2009 September 2009 October 2009 November 2009 December 2009 July 2009 to December 2009 vs. July 2008 to December 2008 Brent Oil $/Barrel 39.5% 29.0% 20.3% 9.0% -1.8% -11.2% -17.3% -22.0% -25.2% -27.5% -28.6% -28.6% -5.2% 0.6% 0.0% 1.7% 3.8% 4.7% -15.9%
Source: Sasol, 2010c. To test whether the Index was relevant to the spot and term purchases, a regression was performed on actual prices (spot and term) against the Brent Oil prices. The results produced a very good correlation between the Brent crude oil prices and each series of spot and term purchases respectively. The worst correlation produced an r² of 0.95, meaning only five per cent of the spot price variation cannot be explained by the Brent Oil price variation. (See Table 4.3 for results). To establish whether the correlation could have produced significantly different results, the P-value was established. The worst figure in bother correlations was 4.7 x 10-15 (spot prices regression), meaning the chance that the regression results are completely incorrect is 4.7 x 10-13 %. Consequently, it can be accepted that it is very unlikely that the results are incorrect and hence the index can be considered to be a fair description of the behaviour of the spot and term prices.
51 Table 4.3: Statistical results of regression analysis Brent Oil and Spot Purchase
SUMMARY OUTPUT Regression Statistics Multiple R 0.97418647 R Square 0.94903928 Adjusted R Square 0.94661258 Standard Error 6.60622884 Observations 23 ANOVA Regression Residual Total df 1 21 22 SS 17067.707 916.48745 17984.194 MS 17067.70692 43.64225955 F 391.0821093 Significance F 4.69877E-15
Intercept Brent $/Bbl
CoefficientsStandard Erro 2.56533708 4.2329105 0.95904324 0.0484958
t Stat 0.606045664 19.77579605
P-value 0.550979698 4.69877E-15
Lower 95% Upper 95% Lower 95.0% Upper 95.0% -6.237482248 11.36815641 -6.237482248 11.36815641 0.858190683 1.059895796 0.858190683 1.059895796
The purchase cost portion of the TCO for the first six-month period was then adjusted downwards by 15 per cent as indicated by the index. This means that the production adjusted purchase cost of US$905.7 million was reduced by 15 per cent (US$128.5 million) resulting in an adjusted TCO of US$777.3 million. The final result was a TCO adjusted for both production and price variation. 4.4.4 TCO Comparison
The last step in the process is now to compare the TCO for July to December 2008, with the TCO for July to December 2009, after making provision for the volume and market adjustments as explained in paragraphs 4.4.2 and 4.4.3. The US$28.95 million benefit was the result of a range of strategic sourcing initiatives which focused on the various TCO elements. Some of the main elements include amongst others, demurrage and freight bill.
52
1200
1000
877.18 28.58
128.45
777.31
800
28.95 748.36
600
400
200
0 TCO July - Dec 2008 Volume adjustment Market adjustment Adjusted baseline Benefit TCO July - Dec 2009
Figure 4.10: TCO comparison for crude oil in Sasol July to December 2008 vs. July to December 2009 Source: Van Niekerk and Sefoka, 2010: 8. 4.5 PROBLEMS IDENTIFIED WITH TCO MEASUREMENT
Within Sasol, various problems with this approach to measurement have been experienced over time and had to be addressed. 4.5.1 Linking of benefits to financial statements
One of the first problems that you encounter from a measurement perspective, according to Swanepoel (2010), is difficulty in linking these buckets to the financial statements due to the fact that the organisation does not budget on a TCO basis but on a direct cost basis, and then also, only per financial cost element. For example, if you consider the TCO of a bearing for a specific financial year, the direct cost will be the number of bearings purchased multiplied by the price per bearing which can be linked directly to the costs incurred on the income statement and in the financial budget. The indirect cost associated with a bearing, which consists of inventory carrying cost, however, cannot be linked directly to the numbers on the financial statement or the budget because these are not budget elements.
53 Internal cost refers to the cost of installing a bearing and relates to various budget elements such as labour, maintenance cost and/or operations cost but opportunity cost which relates to the cost of downtime should the bearing fail, is again very difficult to link back to the financial statements due to the same reason stated above. The impact of the lost production would indirectly impact the turnover, but not only is this extremely difficult to quantify, proving the direct relationship between a bearing failure and loss in sales seems an almost impossible task as various factors need to be considered such as, for instance, availability of buffer stock or the specific reasons for the bearing failure (Swanepoel, 2010). 4.5.2 Availability of data
Van Wyk (2010) stated that one of the biggest problems in measuring TCO is the availability of data. In Sasol, there are more than 13 enterprise resource planning (ERP) instances which function with little or no interface and result in the task of drawing data to populate a TCO model on a monthly basis, being a very time-consuming task. In addition thereto data for many of the cost elements of a TCO model, is not available in the formal ERP system. One therefore has to rely on manually-compiled reports from informal data sources which pose major accuracy and integrity risks. 4.5.3 Establishing a market index and activity adjustment
The problems experienced with regards to the above are as per the detail discussion in paragraphs 4.3.1 and 4.3.2 of this research report. 4.5.4 Time and resource constraints
According to Swanepoel (2010) the time and resources required to track value released at detail level as explained in this chapter, are not warranted for all commodities, as in some instances this may lead to more focus on the trading than on the actual process of strategic sourcing and the continuous search for new optimisation opportunities. It is due to these problems that a firm decision was taken in Sasol, to create a set of ground rules for tracking and measurement of the impact of strategic sourcing, and in order to create a more practical approach to the measurement of the value-add of strategic sourcing while still remaining within the framework of the TCO approach (Bornman, 2010a). This is analysed in great detail in Chapter 5.
54 4.6 ? ? ? ? ? ? ? ? 4.7 KEY LEARNINGS TCO encompasses all cost elements of a commodity. To effectively measure TCO improvement on a year-on-year basis, the baseline needs to be adjusted for market changes and activity changes. For TCO market adjustment an independent index needs to be established. This index is a function of the true cost elements of the TCO. The index has certain shortcomings which need to be considered. Activity adjustment is difficult, as an appropriate activity level is difficult to find. Measurement of TCO is a difficult and time-consuming process. Data availability is a major stumbling block. CONCLUSION
The TCO model approach to the measurement of value released from the strategic sourcing process is an excellent solution to the problem of proving once-off value-add through application of strategic sourcing principles. In Sasol, this approach has been well entrenched over the years after Sasol was persuaded in the early 2000s to implement strategic sourcing and the Sasol Board required continuous feedback on the progress made in the Sasol Group. Not only does this approach provide an indication of the value-add through various strategic sourcing activities, but it also serves as an excellent gate keeper over time to ensure sustainability of achieved results by ensuring that no leakages occur, and provides for immediate corrective action in cases where leakage does occur. Simultaneously, the independent market index serves as a barometer for movements and activity in the market which offers the ability to monitor the financial impact thereof on a continuous basis. Unfortunately the continuous tracking and monitoring of a commodity at this very detailed level is time-consuming, complex and poses many challenges and risks. To counter the various challenges and address the issues, Sasol had to adapt its approach to measurement by providing for a more practical measurement methodology which is discussed in the next chapter in more detail.
55
CHAPTER 5 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: SASOL BENEFITS MODEL
5.1 INTRODUCTION
Victory is sweetest, when you’ve known defeat ~Malcolm Forbes. Due to the problems experienced with full TCO measurement as discussed in Chapter 4, Sasol had to re-design its measurement model in 2003, which lead to the establishment of what is known today as the benefits model and which is currently used in Sasol. At that point the organisation experienced that more time was spent on collection of data and measurement of benefits, than focusing on actual true value-adding activities to create value, and implementation of cost optimisation ideas (Van Wyk, 2010). The new approach to measurement was still based on the original principles of TCO measurement as described in Chapter 4. The model is based on five requirements for benefits calculation. The benefits are then categorised into different batches in accordance with the number of requirements that can be complied with (Swanepoel, 2010). The requirements lay the foundation for measurement, and value, referred to as benefits, can be reported in various segments depending on the level of complexity involved in implementation of the optimisation ideas. This allowed strategic sourcing teams to focus more on the actual value-adding processes and activities. This chapter focuses on the Sasol Benefits Model and the principles it is built on, as well as the requirements set for measurement and the governance around the reporting of the value released through the strategic sourcing process. 5.2 BENEFIT CATEGORIES
The categories of benefits provide the structure that effectively assesses the identification, calculation and tracking of benefits that originate from the Sasol strategic sourcing process (Sasol, 2010a: 8). The benefits categories firstly differentiate between sustainable and once-off benefits. Sustainable benefits are further categorised into three types into which a benefit will be classified based on the level of compliance with the set requirements for each category (Swanepoel, 2010).
56
Benefits
Sustainable
Once-off
TCO
Idea tracking
Price containment
Figure 5.1: Classification of benefits in Sasol Source: Sasol, 2010a: 9. Figure 5.1 illustrates the benefits classification as it is used in Sasol today. The study now focuses on analysing the model by first distinguishing between the principles of sustainable and once-off value release and thereafter a detailed analysis is done of the five measurement requirements for sustainable benefits, as developed by Sasol. Lastly, the categorisation of sustainable benefits into its three sub-categories: TCO, idea trading and price containment is discussed. The study also tries to highlight that the TCO principles are still complied with. 5.2.1 Sustainable versus once-off benefits
Sustainable benefits refer to the value released as a result of optimisation ideas implemented in a specific financial year and which yield continuous benefits year-on-year. Sustainability is generally achieved when a permanent change in a process is made and successfully implemented. To ensure sustainability it is important that the new way of doing is accepted, embedded and becomes a standard working procedure in the organisation. According to Sasol (2010a: 9) it is easier to achieve sustainability in an environment which is structured for repetitive activity, but it requires a huge effort from the strategic sourcing teams to ensure that these benefits are sustained over time (Van Wyk, 2010). The principle of a sustainable benefit is illustrated in Figure 5.2 below, where the red line indicates the unit cost of a commodity in the manufacturing process and the green line indicates the new unit cost after a sustainable idea, i.e. a change in specification, was implemented.
57
Cost
Current Effect of sustainable idea New
Time
Figure 5.2: Sustainable benefits illustration Once-off benefits are benefits achieved in a particular financial year, but are not sustainable beyond the period in which they were achieved, for instance a once-off discount negotiated with a supplier. At the end on the benefit period, the cost will revert back to the original level (Sasol 2004: 113). The principle of a once-off benefit is illustrated in Figure 5.3 where the red line again indicates the current unit cost of a commodity in the manufacturing process and the green line indicates the change in the cost structure.
Cost Once-off benefit
Current
Time
Figure 5.3: Once-off benefits illustration
58 5.2.2 Five requirements of benefits calculations
Figure 5.1 illustrates how benefits can be classified in various categories. The difference between these categories relates to the five requirements developed by Sasol for benefit calculation. The requirements as illustrated in Figure 5.4, are used in various combinations to result in a benefit being classified into one of the categories and are now discussed in greater detail.
MECE
TCO Model
Requirements
Baseline
Index Activity level
Figure 5.4: Five requirements for benefits calculation Source: Adapted from Sasol, 2004: 115. 5.2.2.1 Mutually exclusive, comprehensively exhaustive (MECE) The requirement of mutually exclusive, comprehensively exhaustive (MECE) is based on the principle of interdependence that exists between various commodities in the production process. As a result of this interdependence, certain benefits realised due to a strategic sourcing initiative, may impact negatively in another area, and therefore the principle of MECE was put in place (Swanepoel, 2010). Mutually exclusive in strategic sourcing refers to the boundaries of a particular commodity that must be properly defined in its relation to other commodities in order to ensure that double counting of benefits do not take place. Comprehensively exhaustive means that all cost drivers influencing a commodity are identified and taken into account. Factors influencing a commodity that are not identified may lead to inaccurate measurement (Sasol, 2010a: 11).
59 5.2.2.2 TCO model The principles of the TCO model were described in detail in Chapter 4, paragraph 4.3. As is explained later, the new approach to benefits calculation did not replace the TCO measurement, but it merely developed various categories of benefits depending on adherence to specific combinations of the set requirements. Therefore the TCO model is still relevant as a requirement. According to Sasol (2010a: 11), the TCO model identifies all elements that drive and influence the TCO of a commodity, and these elements are then classified in four cost buckets. Refer to Figure 4.1 in paragraph 4.2 for detail on TCO cost buckets.) 5.2.2.3 Activity level In order to be able to manage commodities and make value-adding decisions, a commodity’s performance must be measured in relation to a productivity indicator, i.e. plant production. Excluding this productivity ratio from benefits calculation may distort the quantification of the benefits achieved. The activity level must be relevant and highly correlated to the usage of the commodity (Sasol, 2010a: 11). 5.2.2.4 Indices A commodity index is the sum of all the variable elements that influence the price of a commodity. The prices of commodities in global markets fluctuate due to many factors, such as: ? ? ? Supply and demand forces; Currency rate of exchange; Inflation.
5.2.2.5 Baseline The positive or negative impact of benefits realised, can not be assessed unless it can be compared to a previous figure. A baseline spend or base price enables comparative analysis and decision making by providing a reference for comparison. A baseline spend/base price is a defined comparable base from the previous reporting period (Sasol, 2010a: 12).
60 5.3 BENEFITS MODEL
Through mapping of the five requirements for benefit calculations, in relation to the benefit categories as explained in Figure 5.1, the benefit model used in Sasol was developed. The Sasol Benefits Model is illustrated in Figure 5.5 and clearly shows how satisfying a specific combination varying from only one requirement to all five requirements per instance, classifies benefits achieved into one of the benefits categories.
Benefits
Sustainable
Once offs
TCOR Index Requirements Baseline Activity level TCO tree MECE
Ideas
Price
Cost
Capital
y y y y y
y y ü y X X
y y X X X
y y X X X
y X X X X
Figure 5.5: The Sasol Benefits Model Source: Sasol 2010a: 12. Now, the five requirements for the three categories described under sustainable benefits are compared to see to what extent this model as discribed in Figure 5.5 was able to address the issues raised in Chapter 4, paragraph 4.5 with regards to the measurement of the strategic sourcing value release by way of the TCO model. 5.3.1 TCO reduction
As already mentioned, the model does not replace the TCO measurement process, it merely develops and expands on it. Therefore it is still TCO reduction. What is interesting to note, however, is that this is the only category which requires compliance to all five requirements and according to Bornman (2010a), this category indicates the highest level of measurement in the group. Sasol sets targets on an annual basis for each strategic sourcing team aimed at increasing the number of commodities measured at this level.
61 5.3.2 Idea tracking
The second category of measurement is called idea tracking and this category requires compliance to three of the five requirements for benefit calculation. The principle applicable when ideas are tracked at this level is closely linked to the main intention of strategic sourcing which is to continuously search for ideas, in conjunction with end users and suppliers, to reduce the cost structure of a commodity. By tracking benefits at idea level, no detailed TCO model exists and therefore benefits can not be proven to be mutually exclusive and comprehensively exhaustive (MECE). In this case, a baseline is established for the area on which the idea is focused and the only cost elements usually adjusted in such cases are the relevant independent index and activity level (Bornman, 2010a). This ensures that in cases where it is very difficult to collect data for the TCO model, the strategic sourcing team is enabled to focus on a specific area and track the progress for only that idea. 5.3.3 Price containment
This is the most general type of benefit reported in Sasol according to Bornman (2010a) and the benefits occur mainly through negotiations with suppliers. In order to calculate the benefit one needs an independent commodity index as well as a baseline price. The positive difference between the percentage price increase/decrease negotiated by a strategic sourcing team, and the percentage increase/decrease calculated by the independent index, represents the benefit that can be claimed for this category. Due to the fact, however, that there is no activity level adjustment, one may end up with the problematic scenario where benefits are only achievable by means of procuring in larger quantities (Sasol, 2004: 118), and strategic sourcing teams are therefore encouraged to move away from focusing on price containment and rather move towards idea tracking and TCO measurement. 5.3.4 Once-off
To claim a once-off benefit, requires at least a baseline cost and index to measure against. This is typical in cases where benefits are achieved through once-off sales on specific commodities, due to oversupply. It is, however, well known in the market that oversupply does not last, hence its classification as a once-off benefit (Bornman, 2010a). For this category, the baseline is represented by the current price, and the relevant index indicates the market movement in the price of the commodity.
62 5.4 SASOL BENEFITS GOVERNANCE PROCESSES
Swanepoel (2010) confirmed that the process of setting benefit targets as well as the reporting of benefits are governed by strict internal processes and that the actual value reported is audited on an annual basis. The governance processes around benefits can be divided into three specific areas of focus namely: i) ii) iii) Annual target setting by the strategic sourcing teams; Obtaining sign-off on ideas implemented; and Lastly, the formal auditing of the value reported each financial year.
It is important to note that strategic sourcing teams are rewarded by means of annual bonuses for achieving the targets for each financial year. The Sasol governance processes are formally documented in the Procedure for Sourcing Strategy Formulation (Sasol, 2010b) and the Procedure for Benefit and Spend Calculations (Sasol, 2010a). 5.4.1 Target setting
Once a year, formal targets are set per strategic sourcing team and which account for 80 per cent of each teams’ performance contract (Bornman, 2010a). These targets are set in accordance with the benefits model and the team must identify opportunities for the commodities in their respective portfolios, and indicate the benefit categories in which these benefits will most likely be realised. The targets are then presented to the main end users, who must also formally sign off on these targets. After the targets have been approved, they are presented to the financial managers of the various business units in Sasol, who each need to ensure that the expected value released by the strategic sourcing teams are captured in the respective business units’ budgets. Thereafter each team’s progress is monitored on a monthly basis, by means of monthly reporting of benefits achieved against the set targets. 5.4.2 Reporting of benefits
According to Du Preez (2010), it was absolutely vital to track the benefits achieved due to the required reports to the Group executive committee on a monthly basis when they started to implement strategic sourcing in Sasol. Within the first couple of months, a team was set up to develop a tracking tool because there was nothing available in the market that could fulfil this requirement. This lead to the development of an in-house system called NGIS, which is still used today. The NGIS system was developed as a benefits tracking and monitoring system (Sasol, 2010a: 13) and serves as a central storage database, where all potential and actual benefits are registered.
63 The NGIS system is also used during the year-end wrap up process, to confirm anticipated and reported benefits. The structure of the NGIS system is aligned to the benefits model and all benefits are captured in the same manner. All benefits reported on the NGIS system must be supported by a sign-on document, supporting the benefit reported. 5.4.3 Benefits sign-on process
Before any benefit targets can be set, end users, also the budget owners, are required to sign a document which signifies their agreement with the target set for the financial year. This is referred to as sign-on by the end user (budget owner). This process was established to obtain alignment between the strategic sourcing team and the budget owner as a means by which to break down the silo method of operation in the organisation. The value released via strategic sourcing can not take place in isolation and therefore a formalised and cooperative process had to be established. Figure 5.6 is an example of the sign-on document used in Sasol. After the benefit has been realised, the budget owner will again sign-off on the value released and only thereafter can it be reported on the NGIS system (Bornman, 2010a).
64
A. Benefit Details Team Name Commodity Name: Financial Year B. Benefit Description Sustainable Benefit information Price Containment Idea realised TCOR Once-Off Once off Cost/Income Once off Capital
Benefit Type NGIS Title NGIS Idea number Benefit description Notes: A short description of how the benefit will be realised and the estimated total value. The BU (if it is a GSST) that the benefit will accrue to. The period over which the benefit will be reported All supporting documents (e.g excel sheet etc) must be kept with the sign-on document C. Sign-on Strategic Sourcing Manager / P&SM Manager / Procurement Manager / Supply Chain Manager Name: Signature: Date: That: The benefit calculation and reporting methodology used are in compliance with the benefit ground rules. The initiative has been implemented and that the benefit is being realised. Sasol Stakeholder Name: Signature: Date: That: The initiative has been implemented and that the benefit is being realised. The TCO methodology is understood and the activity levels used (in the case of TCOR) in the calculation are correct. Index Centre of Excellence Name: Signature: Date: That: The Indices used in the benefit calculation are representative of the commodity/service
Figure 5.6: Benefit sign-on document Source: Sasol 2010a: Annexure A.
65 5.4.4 Auditing of benefits
As stated before the reported benefits are audited on an annual basis and this requirement also forms part of the Sasol formal auditing schedule. The audit process consists of the following actions (Sasol, 2010a: 14-15): i) The team presents a list of realised benefits as registered in NGIS that has been reported for the financial year; ii) Initially, 80 per cent of the value of reported benefits is selected for the audit process. Reported benefits are also selected based on the uniqueness and value of the underlying principle of the initiative; iii) iv) A random selection from the remaining 20 per cent also forms part of the audit scope; For the selected benefits, sign-on documents are assessed and should reported benefits not be supported by completed sign-on documentation, they are rejected from the reported figures regardless of the fact that they have been implemented; v) Where proof of sign-on is provided, the benefits are analysed by auditors to understand the principles which govern the implemented initiative; vi) All fundamental assumptions that have been made and the validity thereof have to be proven and are assessed; vii) ? ? ? ? ? ? The following aspects are assessed: Whether the benefit is sustainable, once-off or both; The method used for calculating the reported saving; Whether the ground rules were correctly applied; Whether the correct benefit classification had been used; Whether the input costs to do the calculations is supported by valid documentation to confirm its origin; Whether the input costs make business sense and the origin thereof is verified where necessary; viii) Next, the auditor ensures that reported benefits, which flows over different financial years, are not duplicated and that benefits are only reported for a 12-month period; ix) Economic indices are evaluated to be representative of the specific commodity or service it represents; and x) Application of the index is evaluated in terms of the ground rules.
66 5.5 ? ? ? ? ? ? ? 5.6 KEY LEARNINGS There is a distintion between once-off and sustainable benefits. The TCO principles are still relevant. The five requirements as developed by Sasol is used to the benefits reported. Target setting is a key element to the strategic sourcing process. End user acceptance of the value added is important. The value-add needs to be taken out of the budget. Auditing of the value-add is important to the integrity of the process. CONCLUSION
In its initial implementation of strategic sourcing and specifically as a result of the complexities and problems experienced with the TCO model of measurement of achieved benefits, Sasol had to adapt its measurement approach to allow for a more practical and user-friendly model so as to not over-complicate its measurement methodology. The measurement of achieved benefits is a very important aspect of the strategic sourcing process as it provides valuable information to senior management on the actual progress made in terms of the value-add of strategic sourcing. Experience, however, proved that an over-complicated system misdirects the focus of strategic sourcing as teams spend unnecessary time on tracking and reporting of benefits, and less time on the actual realisation of optimisation ideas. The accuracy and integrity of benefit reporting is the last crucial link, and to ensure this, stringent governance processes were developed which are still in place today. Adherence to these processes is audited on an annual basis as part of the formal audit process in Sasol and to ensure accurate and reliable benefit reports. Another important aspect to consider is that a function need to perform at all levels in an organisation to be seen as a value-adding partner. Chapter 6 will focus on what needs to be in place for a procurement function to be seen as a truly value-adding function which is more than just the value released by the strategic sourcing process.
67
CHAPTER 6 SUSTAINING A WORLD-CLASS FUNCTION
6.1 INTRODUCTION
We were born to succeed, not to fail ~Henry David Thoreau. Sasol extracted more than R3.8 billion in value from the procurement of goods and services in the organisation, through its strategic sourcing process over the past ten years. But, a function like procurement can not only focus on strategic sourcing in order to be seen as a value-adding function. Within Sasol, the procurement function came to realise that, despite the well-functioning strategic sourcing process, and the sustainable results delivered as a result thereof, the function as a whole needed to perform at all levels. There is a principle of procurement referred to as a “non-negotiable” which is to procure the right product, at the right time, at the right price and at the right place, which still holds true today (Brockwell, 2007: 1). When the procurement function is unable to satisfy the needs of the end user, perceptions become negative towards the function and all the value released to date as a result of its world-class processes also starts to lose its appeal. One may even notice a slow descend into losing the prized seat at the boardroom table and the organisation starts to see procurement as just another function again, with merely a transactional mandate as was the case historically. Against this background, the Sasol procurement function realised that it had to review its value proposition in the wider sense than just its strategic sourcing process and in the process a hierarchy of agendas (HOA) was established which caters for all the important elements in procurement and not only strategic sourcing (Kritzinger, 2010). 6.2 KEY REQUIREMENTS FOR AN EFFECTIVE PROCUREMENT FUNCTION
In order to manage a procurement function as a strategic, value-adding partner in the organisation, it is extremely important to ensure that the function’s vision, purpose and value proposition is aligned with that of the broader organisation’s vision and purpose. To achieve this, the respective business unit procurement functions in Sasol, jointly developed a vision and purpose statement that was aligned throughout the Sasol group of companies (Kritzinger, 2010). 6.2.1 Vision
Kotelnikov (2010: 1) defines a vision as an inspiring statement of what the organisation intends to become and to achieve at some point in future. A vision refers to the intentions that are broad, allinclusive and forward thinking. This same principle is true for a function that wants to stay relevant well into the future.
68 The vision for the procurement function in Sasol also reflects this principle of continuously striving to be the best. The vision of the Sasol’s procurement function, according to Kok and Sefoka (2008: 6) is: “To be a world-class procurement business partner.” According to Kok and Sefoka (2008: 6), the vision expresses two very important future desires of the procurement fraternity. The first is to be a “business partner”, in recognition of the fact that the procurement function must enable the business to reach its objectives. The second is to be “worldclass”, thereby communicating a commitment to employ procurement practices that meet or exceed their internal customers’ expectations. 6.2.2 Purpose
According to Williams (2008: 1), understanding the purpose of a function affects the function’s performance. A purpose brings deeper meaning to the function and the function is not only delivering a service, but actually understands how its actions contribute towards the organisation’s overall purpose. The purpose of the procurement function in Sasol according to Kok and Sefoka (2008: 6) has been defined as: “Apply and ensure functional procurement excellence in order to (i) shape, (ii) continuously improve and (iii) safeguard Sasol’s competitive advantage.” The purpose also identifies three key activities that enable the function to contribute to the business’ competitive advantage. The description and intent related to each of the three activities are described in Table 6.1 below, and were derived from the work of Kok and Sefoka (2008: 7-10). Table 6.1: Sasol procurement function purpose
Main activities Shape Description Activities that the procurement function engages in together with the business, to add value to the business and its strategies Activities that it must improve at in order to support the maintenance of the Group’s competitive advantage Actions Business strategy Sourcing strategies to support business Competent people Efficient processes and systems Benchmark the procurement function Produce market intelligence Create new benefits through the strategic sourcing process Stable supply of goods and services at the required price Apply risk management strategies. Build reliable supply networks
Continuously improve
Safeguard
Addresses issues of business risk as far as the supply markets to the Sasol Group and application of relevant governance to internal processes are concerned
69 i) The shaping activity refers to the establishment of sourcing strategies that support the business strategy together with efficient processes and systems. ii) The principle of continuous improvement, which is also one of the core values of Sasol, refers to the process of continually seeking ways in which to do things better and more effectively. This is achieved in Sasol through continuous benchmarking of the procurement processes and the function as a whole. iii) Safeguarding focuses on the protection of the company against risk. As the custodian of a spend base of more than R57 billion, the procurement function has an important role to play in ensuring ethical and honest business practices in the management of an expenditure of this magnitude on an annual basis. 6.2.3 Value proposition
The principle of a value proposition is sometimes confused with marketing and market offerings to customers. But if the intention is to be a world-class function, and more to the point, a world-class procurement function or world-class marketing function or a world-class human resources function, a solid value proposition must be developed for customers, and this, in the examples above means internal customers. Lake (2010: 1) says that a value proposition needs to be clear and concise and it equips you with the following benefits to your customers, namely: improves your operational efficiency and it will help you to increase not only the quantity, but also the quality of your offering to your customers. Kok and Sefoka (2008: 8) define the Sasol procurement value proposition as follows: “The strategic formulation and implementation of procurement functional strategy through competent people, effective processes and systems and stakeholders, in line with global best practices and supply-chain strategic framework.” The value proposition communicates the benefits that Sasol would derive from an effective and efficient procurement function. The Sasol procurement value proposition refers to two groups of people, namely: internal competent people and the stakeholders of the procurement fraternity. According to Kritzinger (2010), the skills base of the people within procurement is a critical success factor through which the function needs to deliver on its value proposition. This implies the appointment of the right people, who are able to deliver value on a strategic level, and who are able to move to a strategic level, away from the traditional administrative and transactional roles. The stakeholders are those people/functions who are the beneficiaries of the value extracted and offered by procurement, and Kok and Sefoka (2008: 9) have identified three key products that procurement offers to its stakeholders and which are described in Table 6.2.
70 Table 6.2: Value release to key stakeholders by procurement
Product Benefits Sourcing strategies Description This is the value release via the strategic sourcing process as described in Chapter 5. Before one can enter the supply market, a proper sourcing strategy needs to be in place. Procurement functions are trained in the preparation of these strategies. Procurement contributes significantly to the business bottom line and in the process collects massive amounts of data, which is turned into valuable information.
Visibility of information
6.3
THE HIERARCHY OF AGENDAS FOR THE SASOL PROCUREMENT FUNCTION
The key strategic sourcing focus areas for the procurement function in Sasol was derived via detailed workshops with key stakeholders in the organisation, in order to do a proper assessment of the needs of stakeholders (Kritzinger, 2010). But, as already mentioned, it is also important to ensure that the key building blocks of the function are in place in order to ensure that the strategic value-add can be delivered. This lead to the procurement function defining a hierarchy of agendas (HOA) to prioritise the initiatives it will embark on. For each agenda, a definition of victory (DOV) was developed against which the function can track its performance (Kok & Sefoka, 2008: 10). The HOAs and DOVs are supported by the vision, purpose and value proposition as discussed in paragraph 6.2 above. As illustrated in Figure 6.1, the HOA as developed in Sasol is presented as a triangle on top of a square that represents the key building blocks that must be in place to ensure that the procurement function operates in an effective and efficient manner. The triangle represents the strategic focus areas that represent the value-add from the strategic sourcing process. One can argue that even if an organisation decides not to embark on the process of strategic sourcing, the elements in the square still need to be in place to ensure a value-adding function. The following section of the report analyses the HOA for the procurement function in Sasol which is described in Figure 6.1.
71 HIERARCHY OF AGENDAS
STRATEGIC
New benefits
Sustain already achieved benefits
Sourcing of supply
FOUNDATION 1) 2) 3) 4) 5) 6) Stakeholder relationships Standardised processes Governance Contract management ERP system support Skills development
TACTICAL
VISION, PURPOSE, VALUE PROPOSITION
Figure 6.1: Hierarchy of agendas Source: Adapted from Kok and Sefoka, 2008: 10. 6.3.1 Foundation
The foundation of the HOA model refers to the tactical aspects that must be in place for a function to operate in an effective manner. Sasol highlights six building blocks that form the foundation of a procurement function. 6.3.1.1 Stakeholder relations According to Kritzinger (2010) it is of extreme importance for a procurement function to understand the needs of its internal customers correctly in order to be able to satisfy these needs. It remains the procurement function’s role to balance these needs with what is available in the supply market. Thus, for procurement to be successful, the function needs to truly understand what the business pressures and priorities are (Kok & Sefoka, 2008: 11).
72 6.3.1.2 Standardised processes Purchasing Insight (2010: 2) states that a procurement process provides a model and framework within which to work to: ? ? ? Save time, and ensure that you obtain the right solution to meet you business needs; Ensure you pay the right price; Ensure that suppliers are familiar with the steps you take and know that they are dealing with a professional organisation. One of the key objectives in the Sasol Group is the drive towards “One Sasol Way”. It is believed that substantial value can be released through the standardisation of procurement processes, and that this will also support governance. In order to achieve this, Sasol has embarked on a project named Functional Excellence of which one of the main deliverables is to standardise business processes throughout the Sasol group of companies (Kritzinger, 2010). 6.3.1.3 Governance According to Procurementleaders (2010: 1), good governance across procurement can be costly in terms of resources, but it is an important basis for increased business performance, reducing risk and making headway in combating the perennial problem of dissident spending. As per the Sasol Code of Ethics (2004), all procurement processes shall be transparent, honest and equally applicable to all parties. The governance procedures and processes related to procurement must be clear, available and accessible to all in the group. It is hence very important that all policies and procedure are clear and auditable and that it covers the main potential risk areas (Bornman, 2010a). Sasol, as required due to its listing on the New York Stock Exchange, must comply with Sarbanes Oxley requirements which have a strong link to the procurement function. 6.3.1.4 Contract management Procurement applies a number of tools in its interaction with the supply market and contracting is one of them (Kok & Sefoka, 2008: 11). It is through the conclusion of a contract that Sasol commits itself to a supplier with the reciprocal expectation that the supplier will fulfil its responsibilities to Sasol’s satisfaction. While the conclusion of a contract can be a lengthy process, it is the very manner in which the process is executed that determines whether the intended relationship becomes mutually beneficial over the term of the contract. Therefore contract management is regarded as an important business tool in the procurement function’s ability to deliver value (Kok & Sefoka, 2008: 11).
73 6.3.1.5 ERP system support The Systems Applications and Products (SAP) ERP system in Sasol is the platform that enables procurement to execute its transactional responsibilities and allows access to end users into the contracts which were established through the strategic sourcing process (Kritzinger, 2010). 6.3.1.6 Skills development The last building block in the foundation for an effective procurement function, is skills development. To engage on a journey to become a world-class procurement function, new skills are one of the most essential requirements to elevate the function from a transaction-based function into a true strategic function. To achieve this, Sasol had to invest substantially in the development of its people over the last number of years (Du Preez, 2010). Sasol also formed an alliance with the University of South Africa (UNISA) to develop a subject specific programme for strategic sourcing as the company believes in the principle of developing its own people (Kritzinger, 2010). 6.3.2 Securing of supply
The world’s business cycle has resulted in challenging trading environments both locally and internationally. This requires additional vigilance on the part of the procurement function. A breakdown or interruption of critical commodities to Sasol’s operations can result in operational breakdown (e.g. lost production time), increased costs and possibe damage to the Group’s reputation and to manage this risk is, fundamentally, to manage supplier relationships. Detailed and thorough supplier appraisal procedures are advisable for efficient supplier management. In general, one should utilise the contracting process as a means of interacting with suppliers, to identify those suppliers whose approach and ethos are broadly consistent with that of your own organisation. A good and reliable supplier greatly increases the probability of effective communication, which subsequently, minimises the odds of supply and demand problems. When working in partnership relationships with suppliers, it is more likely that suppliers will highlight anticipated and/or potential risks in the supply chain. Effective supplier relationships require a delicate balancing act. Over-reliance on any one company significantly increases supply risks and it is consequently important to have contingency plans in place, to counter all potential supplier failures. 6.3.3 Sustain benefits already achieved
Since the year 2000 the procurement function in the Sasol Group has delivered cumulative benefits of about R3.8 billion as defined by the Group’s strategic sourcing model. These benefits were based on the sound and rigorous application of strategic sourcing principles which have become more relevant than ever under the current and continuously developing economic climate.
74 By combining the first two levels of the HOA, Sasol is in a position to put up a formidable fight against inflation and price volatility to sustain the gains made thus far. 6.3.4 New benefits
The top element in terms of HOA is, however, the extraction of new value. Sasol has set itself a new target in excess of R2 billion, to be achieved by 2012 (Kritzinger, 2010). Kritzinger (2010) describes this as the “ticket to the dance” which is still valid today or in terms of what matters, the ticket to the boardroom seat. 6.4 DEFINITION OF VICTORY (DOV)
From the HOA, a DOV for Sasol procurement was developed in order to ensure that the function stays relevant to the Group and to support its management in tracking the overall performance of the function on a continuous basis. These DOVs also form the basis of the procurement management’s performance contracts in the Group (Kritzinger, 2010). The DOV’s are grouped per HOA and are measured accordingly. The DOV is described in Table 6.3 as per Sasol (2009: 3). Table 6.3: Sasol Procurement DOV
HOA element Foundation Key focus area Preferential procurement Enterprise development Compliance to governance Adherence to competency framework Service level agreement Supplier management strategy implementation Supplier performance against agreed KPIs Supplier management strategy where needed % of spend on terms agreement % of spend on TCO principles % of TCO track on idea level New value released Target 14/20 12/15 80% 80% 90% 100% 85% 100% 90% 60% 80% R2 billion Target date 2011 2011 2012 2011 2012 2011 1012 2011 2012 2012 2012 2012
Securing of supply
Sustaining of benefits New benefits
Source: Sasol, 2009: 1. The above targets are tracked on a quarterly basis and feedback is given to senior management. Any deviations reflected in the quarterly management reports are immediately addressed with appropriate corrective actions.
75 6.5 STRATEGIC SOURCING AND THE GLOBAL ECONOMIC CRISIS
During September 2008 Sasol found itself under severe pressure as a result of the then unfolding global economic crisis. Fortunately and largely credited to its well-established strategic sourcing process, Sasol was able to respond to the crisis immediately by engaging with its suppliers in order to lower their costs in accordance with the global commodity trends at the time. A detailed portfolio analysis had been completed on all suppliers previously as part of the strategic sourcing process and this enabled procurement to immediately engage in re-negotiations with its key suppliers. Progress made through this additional initiative was tracked and measured on a per supplier basis (Crafford, Kritzinger & Joubert 2009: 1). For this additional price reduction initiative, a target of R1400 million was approved by the Sasol Group executive committee, and it was achieved by December 2009 (Crafford et al., 2009: 1) but had it not been for the well-entrenched strategic sourcing process in Sasol procurement, such prompt action would not have been possible. 6.6 ? ? ? ? KEY LEARNINGS For a function to stay relevant, it needs to develop a vision and purpose that is aligned with that of the organisation. A function needs to be clear on its value proposition and who its customers are. A procurement function is built on solid governance, systems, skills, contract management and business processes which need to be in place to support any strategic insights. The strategic initiatives are: releasing value, sustaining of existing value and securing of supply. 6.7 CONCLUSION
Even though the newly-established strategic sourcing unit of procurement adds considerable value to the Sasol bottom line, sustaining the function and the benefits derived from its process is not easy and for the procurement function to sustain its value-add as a strategic business partner to the organisation based on the creation of TCO value alone is not feasible. It is therefore very important that a proper vision and purpose statement be developed by the procurement fraternity to which people in the function can aspire to and which can guide the function towards future success. For procurement to achieve world-class effectiveness and efficiency, it must also understand the needs of its various stakeholders and create ways to ensure that procurement’s entire value proposition can accommodate these different needs. To understand stakeholder requirements entails a detailed stakeholder needs analysis which has to be conducted through intensive
76 stakeholder interaction, such as workshops, which will enable procurement to develop its agenda of focus areas to which the function should align itself for future success. The identified focus areas are thereafter captured in a hierarchy of agendas (HOA) which assists the function in prioritising its actions. For each HOA, a definition of victory (DOV) is developed against which the actual performance of the function is measured. The result thereof is that the value released via the strategic sourcing process, is now only one of the measurement areas of procurement which as a whole can provide a true value-adding, sustainable value proposition to the organisation.
77
CHAPTER 7 CONCLUSION, KEY INSIGHTS AND RECOMMENDATIONS FOR FUTURE RESEARCH
7.1 INTRODUCTION
The purpose of this study was to explore the value a procurement function can add to an organisation through the implementation of strategic sourcing as a business process, and direct specific focus to the methodology behind the measurement of this value-add in the organisation. In order to gain more insight into the potential value that procurement can add, research was conducted on the Sasol case study. Sasol embarked on a journey to implement the process of strategic sourcing in the organisation in 1999, and today, is rated to be among the top ten per cent of procurement functions in the world as surveyed by McKinsey and Company. The research question for this study was formulated as follows: “How to create a value-adding procurement function in an organisation through the implementation of strategic sourcing and how to measure the value-add as a product of the process?” Chapter 1 focused on the research methodology that was followed in order to address the research question. The research methodology was based on an analysis of the Sasol case study, and a comparison thereof to current academic literature. The detail in the Sasol case study was obtained through an analysis of internal Sasol documentation and conducting interviews with key people in the organisation, who were involved in the implementation and further development of the strategic sourcing process in Sasol. Chapter 2 recognised the fact that a procurement function can fulfil a value-adding role in any organisation as proven in Porter’s Value Chain Model (Business Policy, 2010: 3). The literature also indicated that an organisation’s decision to implement the strategic sourcing process should be a calculated decision, based on the nature of the organisation’s spend base, due to the substantial investment required for implementation of the process. The rewards however, can be considerable, measured through the application of a proper balanced scorecard to measure all facets of the function, as a procurement function’s effectiveness and efficiency should not be limited to the application of strategic sourcing, but measured as a complete, value-adding, crossfunctional business partner. The principles laid down in Chapter 2, were then tested in Chapters 3 to 6, against the practical experience in Sasol since inception of the strategic sourcing process up to today. It was quite interesting to note the extent to which the theoretical principles, and Sasol’s experience over the last ten years correlated with each other. The one unique element to the Sasol case study, was the effort put into the development of a practical, user-friendly measurement model after it was found
78 to be the missing link in ensuring that the value-add of the procurement function was measured and reported accurately and reliably. Chapter 3 firstly examined the process that Sasol followed to come to the decision to implement the strategic sourcing process and secondly the implementation process that was followed over the initial 24-month period. Chapter 4 investigated the measurement principles and methodology, and the TCO model that is used by Sasol to measure the performance of its procurement function. The practical application of these principles was then illustrated on crude oil as the commodity with the highest spend in Sasol. The focus of Chapter 5 was Sasol’s adaptation of the TCO model of measurement, into a more practical model, today known as the Sasol Benefits Model. This model was developed after the TCO model of measurement was found to require such an enormous amount of input data on a regular basis, that the measurement of value-add in procurement became a time-consuming adversary to the actual intended focus of strategic sourcing. Chapter 6 provided key insights into the way a function needs to align itself to the strategy and vision of the organisation in order to stay relevant. Sasol had to create definitions of victory for its procurement function to review and develop all the dimensions of the function despite the substantial value unlocked by the strategic sourcing process which could lead to a narrow based focus on only this process. The aim was to achieve world-class effectiveness and efficiency as a complete procurement function, which required a properly defined functional mission and vision statement, aligned to the vision and strategy of the organisation. This research study provides insight into the value proposition of strategic sourcing, the measurement methodology for measuring the value-add contributed through the process, and guidelines for embarking on the journey of strategic sourcing. 7.2 7.2.1 KEY LESSONS LEARNT Procurement can add substantial value to an organisation
The potential benefit of implementing strategic sourcing can be between five and ten per cent of the total spend on goods and services in an organisation. In the case of Sasol, R3.8 billion in value has been released over a ten-year period. The implementation of strategic sourcing should follow a deliberate choice in the organisation to embark on this process as it requires substantial investments in skills, technology and change management. The required investment is in fact so considerable that a burning platform is usually needed to steer management in the direction of implementing this process.
79 7.2.2 Strategic sourcing is not a project, but a new business process
As suggested in this study, the implementation phase of strategic sourcing should be executed by means of a formal project but despite the project execution approach to implementation, it merely serves as the launch pad for a new sustainable business process. The new process should be documented and governed through a formal process and/or procedure of continuous improvement as it signifies a new approach to procurement in the organisation. The project phase assists in delivering the immediately obtainable value and creates an environment within which a proper spend analysis can be conducted as well as proper analyses on the first round of commodities can be made in accordance with a formal process. 7.2.3 Effect of the market and activity levels on a commodity
When measuring the effect of strategic sourcing, a proper understanding of the market in which that commodity is procured is required, and for this an independent commodity index needs to be developed. The index is a function of the true cost elements of the TCO of the commodity and in order to effectively measure TCO improvements on a year-on-year basis, the baseline needs to be adjusted by taking into account market and activity changes. 7.2.4 Value released can be once-off or sustainable
The value released by the process of strategic sourcing can be categorised into either a once-off benefit which means that the benefit will only occur for a specific time period where after the commodity will move back to the original cost level, or a sustainable benefit which means that a structural change has occurred in the TCO of the commodity and the benefit derived from it is sustainable forever. A sustainable benefit indicates a permanent lowering of the cost curve of the commodity. 7.2.5 Importance of governance in a strategic sourcing process
In order to ensure that the strategic sourcing process is adhered to, formal governance needs to be in place. In addition, the value that is reported as savings, value or benefits need to be audited annually to ensure a legitimate and accurate process, because whatever value is released through the process is removed from the budget of the end user to ensure that the full value of the benefit is reflected on the bottom line of the organisation. 7.2.6 Total functional value-add important to stay relevant
As the process of strategic sourcing becomes well embedded in an organisation, and value is released on a continuous basis, the procurement function as a whole needs to perform at all levels to ensure that the function remains relevant. A balanced scorecard approach is recommended for the development of an effective and efficient procurement function, as this method of measurement covers the financial as well as the non-
80 financial aspects of the business. The measurements need to be aligned with the vision and purpose of the function, which in turn needs to be aligned with the overall vision and purpose of the organisation. The benefit of this approach is that the true value contributed by the function is visible to all stakeholders, and the function can be viewed in its rightful status as a value-adding partner and not only as a strategic partner. 7.2.7 Strategic sourcing creates a platform from which to respond in times of crisis
Through the process of strategic sourcing, a formal sourcing strategy is developed for each commodity which entails intricate knowledge in terms of commodities. As a result, the detailed cost structures of commodities are known and an organisation can rely on this process to be able to provide the information required to respond in times of economic crisis. The platform is in place, suppliers are known and the spend pattern of the organisation is known which enables the organisation to respond in an effective manner during difficult economic times by being able to immediately re-evaluate its supply base and renegotiate with suppliers or changing suppliers if need be. 7.3 RECOMMENDATIONS FOR FURTHER RESEARCH
Given the background of this study, the following is proposed for further research to be conducted on this subject: i) A detailed analysis of the psychological impact on an organisation when transforming a function from a traditional transactional focus into a strategic function; ii) The effect of technology support when transforming a traditional function into a strategic function; iii) The change management process in the establishment of a strategic sourcing procurement function; iv) The implementation of strategic sourcing across different countries and major pitfalls to avoid; v) 7.4 The effect of low-cost country sourcing on the South African procurement fraternity. CONCLUSION
Procurement can be a true value-adding function in an organisation which can create a competitive advantage for the organisation. To extract this value requires the implementation of a new business process, and consequently a formal business decision by senior management before it can be implemented. Such a decision requires dedicated support in the form of investments in skills, technology and process engagement to make it a reality. Implementation is a distinctive separate process best served by a formal project phase, where after the new business process can be implemented in the organisation through formal procedures to which compliance needs to be governed.
81 The value released by this investment can be between five and ten per cent of the organisation’s total procurement spend and the value can be added directly to the EBIT of the organisation. When an organisation invests in, and embarks on a journey of this nature, the measurement of the value-add contributed by the process becomes extremely important as a means of proving return on investment, continuous improvement and sustainability. In order to fulfil this essential requirement, the organisation also needs to develop a formal measurement system, for reliable and accurate measurement and reporting of the value unlocked through application of its new process. For a procurement function to be truly successful and remain effective and efficient on a sustainable basis, the function needs to align its vision and purpose with that of the organisation it serves. To direct the focus of the procurement function correctly, a proper definition of victory should be developed against which the function’s performance can be measured in order to ensure that the procurement function sustains its position as a value-adding, world-class strategic partner in business.
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APPENDIX A TRANSCRIPT OF INTERVIEW MR RADIE VAN WYK
Mr. R. van Wyk interview transcription Interview held on Thursday 18 May 2010, Johannesburg Johan: Radie, you started the strategic sourcing process in Sasol around 2000. Can you just explain to me what triggered the decision in Sasol to start with a process of strategic sourcing in 2000? Radie: The main drive behind this was the fact that during the late 1990s, the oil price fell to about $10 per barrel.Top management, Peter Cox, then started the process where the whole company was sort of organised in a way to curb cost. At the time there was a company in South Africa called McKinsey Incorporated and they had a philosophy, a methodology that was applied overseas and they had recently introduced it into the South African environment and at Iscor where I was then involved in the process. When Sasol wanted to know more about the process, I undertook and played the role to introduce the strategic sourcing concept into Sasol with the objective to cut input cost out of the system. The original intent and the original spend base analysis indicated to us that it was possible to reduce the input cost by about R800 million. The R800 million was more than the net profit that the whole company made at that point. So when we presented this case to top management during the latter part of 1999, they were very reluctant to believe that it is in fact possible to take out such a huge number and we had to go back and revise our figure. We eventually came back and committed ourselves to a R400 million saving over a period of three years. The whole thing was driven by the need to make Sasol more profitable. Johan: Will you then say in your experience, is it worthwhile today to start with a process of strategic sourcing in the absence of a case for change? Radie: I would say it is almost impossible. I mean you have to have either a burning platform, which Sasol had, or you have to have a compelling case for change. In both cases you have to understand and know what your spend base and absolutely depending on the processes that you follow at the time, the possibility, the potential varies in my mind between 2 per cent and 15 per cent. In that sense you have to be able to define those figures in the sense that you must be able to prove or put a compelling case to management on the value-add in it for them. Because we have to understand it’s an expensive process. It concerns consultants, like the McKinsey’s of the world,
87 and it concerns implementing processes within the company which needs some different skills at different levels, mainly or mostly at the much higher level that’s normally used in a procurement environment. So it is an expensive process but the turnover or the benefit that you get is big; for Sasol it was in the region of R10 to each R1 you spend. So for us to be able to gain R400 million we were spending in the region of about R40 million. Johan: If you look at the evolution then in Sasol of the procurement function, how can you describe it when you started around 1999/2000 up to what we have today? Radie: Well, during the late 1990s Sasol was a very traditional environment where most of the businesses were decentralised and purchases were done at the business units. Meaning, there was very little economies of scale and nothing, if at all, economies of skill. So in that sense when we started this process it was purely a price-driven environment where value-adding was very limited. We had to grow this process through the strategic sourcing process to an environment where Total Cost of Ownership is the main drive and the criteria that we were using to determine whether we are successful or not. In that process the two fundamental principles that we were looking at, which was not present in the old Sasol environment, was economies of scale where we could group the spend of the company together, and by having bigger margins, bigger leverage on our suppliers in terms of our spend. That was the one area we had to look at. The others were economies of skill, and cross-functional collaboration where we brought technical people and the production people into the process and jointly as a working community, identified opportunities. Johan: Can you then describe for me the strategic sourcing process? You mentioned ideas, you mentioned end users, and you mentioned cross-functional collaboration. Radie: Sasol was organised in silos. One silo is maintenance, the other silo is production and the third silo is procurement, and those silos were individually organised in such a way that they had their performance criteria, which was independent of each other. And it was in some cases actually working against each other. What we did was, we started to follow the cross-functional collaboration process where we brought people together in teams and we were working in, best people from procurement, put them together, do calculations and they identified improvement ideas. First of all they identified ideas in and around the work environment. They quantified those ideas by judging and adjudicating the possibilities of the opportunities and putting value, rand value to it. In that process they were setting inspirational targets in the sense that they would say we’ve got this specific commodity and this is our spend base. Let’s say we were spending R200 million
88 on it and they would come up with the figure saying, on the R200 million we believe there’s a 10 per cent stretch possibility. 10 per cent on that is R20 million. And by having that stretched target, you send the people away and they do some research. They generate ideas in collaboration with all the stakeholders in the process. And after adjudicating and valuing the ideas they come up with a figure that was then measured against the 10 per cent. And in some cases, actually most of the cases they exceeded the 10 per cent by a long way. Johan: How did you go about letting people buy in on such targets? Radie: Well, in a company like Sasol where everybody believes it’s a well-run company, which it still is, talking of a 10 per cent improvement is exorbitant and people tend to not take it seriously. So what we did was to slowly but surely take one step at a time and our slogan or our belief at the time was ”success breeds success”. So you start by taking an environment where, and you focus on the environment, and you actually deliver. The ticket to the dance that will secure your success is to deliver on promises. So if you made a promise, you must ensure that you adhere and that you deliver on that promise. And if you can exceed the promise, even better. That’s why I said; in most cases we actually exceeded the original promises. And by doing that, we were drawing attention from all over the company where people said, but gee whiz, this thing can work. And if it’s working for one area, then the immediate question is why is it not working in a different area or in another area. Because whether we liked it or not, not everybody in the company was very excited about this process and they simply didn’t believe us to start with. But gradually we had to prove to people that this process is in fact well defined and it’s working well, and by implementing ideas and making sure that the ideas are well implemented and well structured, and workable, we slowly gained access to more and more areas which eventually became a way of life. Johan: The decision on where you start, obviously you can’t tackle the whole spend base at once. How did you go about to determine which commodities to focus on? Radie: The traditional Sasol was an environment where we had little feel for actually how much we spent. So the very first place that you start is to determine and find ways to do a spend analysis. Understand where you spend, how much you spend and with whom you spend it. Because unless you know that, your opportunities become depleted and you have no real ground of capturing the economies of scale or economies of skill. Once you have a proper, well-defined, flexible spend base which you can rely on, then only do you start by saying okay, which are the biggest, where are the areas that I can improve easily and where are the low-hanging fruit. So we started really by
89 identifying the low-hanging fruit. By low-hanging fruit I mean what was easy to implement and what was the best, the highest yield that you could receive. By doing that and understanding that, we were able to very easily prove to people that in fact there is a tremendous opportunity. Johan, Was it an easy process in Sasol to analyse the spend base? Radie: It was extremely difficult and the main reason is there was no standardisation in the Group and people bought the same things from various businesses, not even understanding that they bought the same thing. The suppliers were taking advantage of that because they were seeing that we were buying the same stuff, but they were not telling us. So we had to go back to the basics and the basics mean that we had to start with a standardised procurement definition of what we buy. And in that sense we embarked on a UNSPC process and methodology to standardise our purchases, so that wherever you buy in the company, the commodity will be described in the same manner and the spec would be standard. And it was only after that, that we started understanding and fully be aware of how much we spend on a specific commodity. And it was amazing what we learnt over the time. The more and more accurate the information became, the more we learnt about ourselves in the process. Johan, You mentioned earlier, the end users and the functions within Sasol. What about the suppliers; what role did they play in this process? Radie: The whole methodology of strategic sourcing is a triangle type of thing where you have three parties playing a role. The one is procurement, the other one is the end user and by the end user we mean maintenance and production. The third party, equally important, is the supplier. And in the areas where we had the suppliers actively participate, the results were astonishing. Not only for us, but for them as well. They also benefited from the process, and the figures I quoted to you earlier did not even include the supplier part of the improvement. My personal belief is that they probably benefited equally to what we benefited. So their participation in the process was vital and is still vital. Remember total cost of ownership involves all the cost in the supply chain. It also involves the whole lifecycle of this product. And in any lifecycle of any product the supplier plays a major role.
90 Johan: During the first few years, where did the bulk of the value come from? End users, suppliers or the procurement environment? Radie: Immediate, low-hanging fruits usually came from the commercial side of the business where we were able to utilise our economy of scale. And that was probably 30 per cent of the total benefit, but at least we had something to show for our efforts. But over time, as the process matured, it was evident that the bigger, by far the bigger portion lies in the utilisation of this commodity. Either by production people or by maintenance consumption. So by adding the end users into the process we benefited in the end about two thirds of the end results. Johan: And value from suppliers’ side? Radie: Well the value of the suppliers’ side was also substantial, but not as big as our own internal value released. But the suppliers played a role in efficiencies in terms of supply and in terms of transport and those things, and with their expertise in terms of the commodity that they sell. Giving us opportunity to play around with some of the products and identify economies of skill and scale that we could utilise. Johan: You mentioned that Sasol started off as a buying organisation totally decentralised. Will you say by embarking on this process we were able to bring procurement to the Board room of Sasol? Radie: Well, in the end it happened, it so happens that this becomes an extremely important part of the Board room and very few of the purchasing strategies that’s currently applied in the Group, I should say all of them, are approved by the Board, directly or indirectly, through a process that we call stakeholder committees. Those stakeholder committees are chaired by mostly Board members of the company. So they take first-hand active participation in this process and they in the end approve the strategies that we put forward. We’re at the point where the company will not put forward any strategic initiatives and/or strategic goals during the year that we are not playing a part of. Johan: Radie, in order to be part of the Board room it is crucial that you are able to measure your value. You mentioned that the process was triggered by a commitment of R400 million. What role did measurement play in this process?
91 Radie: Well that’s absolutely crucial that indeed we are able to consistently prove to our constituency that the value that comes to the table is indeed being seen on a bottom line. So for that reason we had to develop our own set of criteria that a saving or a benefit of the TCO improvement had to adhere to. What we did in the first year, we applied those measures and we brought in an independent auditor from outside the company to audit those figures and to indeed indicate to our Board that this is in fact the case. So we went through a rigorous process firstly to define what a benefit is, to understand and define and declare where that sits on the bottom line, and then bring in independent auditors to verify that. But without a set of criteria that is non-negotiable, you will not be able to define the value that this process brings, especially if you spend quite a couple of million on the process. You have to prove to people that in fact you are yielding your ten times or whatever the case might be. Johan: So what you are saying to me is to be part of the Board room agenda, you need to be able to talk rands and cents. Radie: Well, rands and cents is the only thing that counts when the bottom line is expressed. And you must be able to prove to everybody in the company to what extent you’ve impacted the profit of the company. Johan: Is it correct to make the assumption that if a function cannot prove its value proposition in terms of rands and cents, you will not necessarily get a seat or be on the agenda of the Board room? Radie: Well, it’s going to be very difficult. This was in my mind the main reason for people or the Board taking us seriously, in that we could start defining our value proposition and not only defining the value proposition but also implementing on a sustainable basis these ideas that were developed by this process. And we were not only able to put that into rands and cents, but we were also able to ensure that over time the sustainability is there and that we’re not falling back into old habits. Johan: You mentioned benefits. What is a benefit? Radie: A benefit means different things to different people. But it’s actually sustainability. First of all it’s the TCO concept. Total cost of ownership, meaning where do I stand in this year versus where should I be the next year? And it’s based on a baseline. So you create a baseline in year 1 and the
92 baseline is developed through the process that I’ve explained previously, TCO and we use the TCO concept. Now you measure that same baseline ongoing and next year you make adjustments for volume changes and for index changes, what the market did to you, to define the second baseline versus the first year baseline. Those are the comparisons. Then what you do is you measure the actual TCO versus the adjusted TCO and that difference is then sustainable improvement, sustainable savings, sustainable benefit. Johan: Radie, you’ve been a consultant now since you’ve left Sasol about four years ago, to various companies in South Africa. The companies that start strategic sourcing today, are they using the same methodology? Radie: Exactly. The principle that came from this methodology that McKinsey brought to the table is after many years still intact. They’re still applied and most of the Fortune 500 companies that I’ve seen over the years apply this process in one form or the other. And most of the companies will tell you straight away that their survival is actually based on the fact that they had the guts to embark on this process. Johan: According to you, what is the biggest flaw or biggest problems that you will encounter in practice? Radie: First of all, to be able to track TCO properly, the harmonisation of the information is of vital importance. Now when we started in Sasol in 1999, we had fourteen different ERP systems. And that in itself created a tremendous back log in the accuracy of information. So we embarked simultaneously on a process that we called data harmonisation. The first step there was to reduce the number of ERPs to four, which improved the figures and the accuracy of the figures substantially. So the biggest problem we had was to have information that you could rely on, that you could consistently make decisions from. To be able to do that you need information that’s accurate and available. Now another problem we had is most of the information was available, but lots of it was outside the systems. Despite the fact that we had fourteen systems, a lot of information was sitting on private laptops and PCs all over the place. So we had to find a way to get that information into the systems in an elegant manner in order not to have a too cumbersome process in getting the information. Johan: What did you do in Sasol to get around all these complexities?
93 Radie: Well, while we were struggling to get the information accurate and to be able to track TCO in its fullest form, we couldn’t sit back and do nothing. So we had a process, an intermediate process that we implemented that we called the Benefit Model. Meaning that you could track ideas but you didn’t have the full impact, you didn’t see the full impact of TCO. But at least you could measure the value of the idea that you implemented. Maybe we should talk about what TCO means. Let me give it to you quickly. TCO basically consists of four buckets and those four buckets represent the whole supply chain or the whole life cycle of the commodity. Now one of the buckets is an opportunity bucket, which is extremely difficult to measure in the sense that it measures the efficiency of a specific product. Now measuring efficiency is extremely difficult if the information is not readily available and it puts your process under scrutiny. So we sort of stayed away in the first couple of years from reporting any of the ideas that sat in that bucket. We were only focusing on the other three buckets, which were easier to measure. The direct and indirect cost bucket. So we had the direct cost bucket, indirect cost, related cost bucket and the fourth bucket was opportunities. So we started every time we ran a value team at the direct cost bucket because that was more freely available. Indirect cost bucket was, if available, mostly available through the supplier or through an unofficial source. Then the related cost bucket was also part of supplier market information. As you build from bucket 1, to bucket 2, to bucket 3 you improved the accuracy of your information going forward. And you could, by having those three buckets, prove sustainability easier. Johan: What was the original response of the people out there when you started putting forward these benefits that are based on a TCO principle and, let’s be honest, it does not correlate one hundred percent with your financial statements because the methodology differs. Radie: What’s an important one is that the financial way of measuring and the commercial way of measuring become a bit difficult. Not difficult in the true sense, but it’s different I should say. No financial system measures opportunity. No financial system really measured indirect cost because it’s a supplier thing. Johan: Yes, only the result…either lesser income or… Radie: Exactly. So the general argument or the general comment we usually had was “but I don’t see these benefits on my bottom line”. Now it is true that it’s difficult or very disguised in the sense that you don’t see it straight away, especially where people overspend their budgets. They will
94 consume these benefits very easily and it falls into the cracks and a person will not accept that you come to him and say “I’ve saved you R10 million”, but if he looks at his budget, his budget is overspent. So we had to create an environment where people would allow us to go into their business, look at their figures, and from a commercial perspective indicate to them where they’re losing money and that indeed if we did not save then the money, their budget would have been R10 million further in the red. Now that is very true in a much matured environment, but at the time the environment wasn’t that matured. So we had to create an environment where maturity was growing. And what we did was we actually, through the process that we implemented, and through the cross-functional principle, we were taking all the ideas to the end users to finally sign on to accept, not only value that we were quoting, but also that they would help us to implement. In fact in most cases they were the implementers themselves. That process helped us to quantify the savings idea initially. In the end we understand exactly how much was saved. Johan: Radie, in your experience is it possible to only have the effective environment built on strategic sourcing? Radie: No, I don’t think so. Johan: So what else did you have to do in Sasol to ensure that you have a very effective supply chain function? Radie: Like I said in the beginning, process only buys you a ticket to the dance. So once you’ve proven to your company that you actually can do and that you actually can perform and that you actually can deliver on your promises, then they will give you an opportunity to do some of the other things. You must remember what I just told you about strategic sourcing is only one part of the supply chain environment. Supply chain consists of a whole host of different functions of which we’ve dealt with procurement per se. so what we had to do is we had to create building blocks, and the building blocks were put in place to enable us to over a period of time deliver against a variety of deliverables that we agreed on. That was the first thing. Second thing, was demand management that we had to deal with in the sense that demand management was actually our interaction with the end users. So in that sense our delivery, our performance was essential and the reason I say that, is that there was no way that we could save R400 million while our service to our end users was of such poor nature that they would rather do it themselves. So we had to sort of, in a joint approach, put the value on the table and from that value then, turn our attention to the other areas of procurement, or supply chain. Meaning that we had to address our process, meaning that we
95 had to look at the efficiency of how we do things. For instance, we decided that our delivery would be on time in full, meaning that whenever you end user wants something, you deliver to him, on the pre-determined date the full order so the end user can perform his duty. It also means that through the whole company we had to develop a whole set of performance criteria. This criteria was derived from the question: “How will we know when we are performing at a world-class standard, two, three, four, five years down the line?” We also understood that this process is not a process that you can implement overnight. It was a journey, it’s not a hundred meter dash, it’s a marathon that we started, and this marathon started with the TCO process and the value teams that we started in 1999. So over time we had developed a set of performance criteria and we also understood that once we arrive at the level which was acceptable to the company, we had to have a number of governance initiatives and documents and processes what would govern the company as a whole. Remember I said when we started: Sasol was a group of individual businesses. Over time that’s grown and merged into one big family where the governance is done at a corporate level. So we do governance at the corporate level but the execution still sits at business level. Johan: Radie, you explained to me the whole process now of establishing strategic sourcing, the journey in Sasol. What will you say today; you’re working with many companies outside Sasol today, what are the things that you need to watch out for before you start destroying the value created by strategic sourcing? Radie: Before we get to what’s going wrong, I just want to tell you for us, for any company to sustain this, to start this process and sustain this process top management buy-in is vital. Without the CEO’s acceptance and acknowledgement of the necessity, sorry, don’t even try it. Now, many companies yes, it’s true that may companies go through this process and they end up in an area where they started. Now, there’s basically in my mind two reasons for it. The first reason is, most companies consider this to be a project. Now a project has a beginning and an end date. So people would ask the questions consistently: when are strategic sourcing teams going to stop, to cease to exist. It’s a consistent on-going sustainable process and as long as this company exists, that philosophy and methodology must be applied. That’s the first, main reason for ending this process or grinding to a halt and going back to the original attempt of just focusing on money. Secondly, if the company runs out of ideas, when the technical ideas and the commercial ideas are not forthcoming any more, the team themselves lose faith in the process and they start losing interest. That’s the second one. The third one is the cost structure. The original structure, where you only have commercial people in, is much cheaper. It’s much more expensive having a cross-functional structure there with high-level, highly-paid, specialised people. Now the pressures in the company consistently drive the cost down. So what happens in the company, instead of having a central-led
96 approach where the efficiency is at the maximum, they start driving cost instead of TCO in their own environment? Johan: You mentioned here the structure is more expensive. Do you need to re-wire the people? Radie: Well that’s where the expensive part comes. You must understand you have to grow an organisation from a traditional buying environment, to an environment where you leverage you buying power, you leverage your cross-functional collaboration skills, you leverage your ability to utilise different people skills and bring them together. So you’re thinking of an individual in that process which is completely differently wired and trained and equipped to handle the new environment where the positional power is gone. It’s now becoming a personal power thing. And I mean positional power is the original environment that Sasol was in, where we had lots of processes and authorities that determine our behaviour. In this process there’s none of that. But for the governance at a very high level, the rest of it will be determined by the skill and the capabilities of the people in the teams. Their ability to take people with them, the ability to excite people about the future, their ability to extract ideas from people where they’re reluctant to give ideas. Meaning that the environment, the mature environment that you are now growing and living in, is the environment where you will extract value for the company. Johan: What were your biggest challenges in the beginning? Radie: First of all, the belief that a department, the traditional department of procurement, does or doesn’t have the capabilities to impact the company to the extent that the methodology requires. And it is true in the sense that if you want to do it with the people that currently sit there: you’re not going to do it. So you have to find, you have to spend money to find people, to bring them into the process so that you can actually demonstrate to the company that you can add value. So that this belief, that a department like procurement can add those big numbers that are usually quoted as an objective for this process. That’s the first one. The second one is most businesses will question the fact that you want to improve, they all have the belief that the company is well run and now you want to, as a procurement environment, want to come and tell them that there’s 10 per cent, possibly or 10 per cent to 15 per cent improvement on that. They fail to understand that. And the third one is, it’s a very labour-intensive process. And the labour part is you need people, you need the best people from the business, not the sick, lame and lazy. You want the best people from the business to come into this process to jointly collaborate, you collaborate with this methodology and utilise this methodology to grow the company and to make possible these benefits. And then
97 another one is people tend to think that the procurement people, Maintenance for instance, procurement is now coming into their environment and procurement thinks that maintenance is coming into their environment creating the impression that you disempower people. But it’s actually the opposite. You empower then to make their own decisions, but their perception in the beginning is that you disempower them and you allow people to tread in different areas where they don’t belong.
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APPENDIX B TRANSCRIPT OF INTERVIEW WITH MR CLEM SWANEPOEL
Mr Clem Swanepoel interview transcription Interview held on 17 May 2010, Sasol Head Office, Johannesburg
Johan: Can you explain to me how you got involved in strategic sourcing around 2000? Clem: I was part of financial and from the financial team I got involved in the strategic sourcing. I think the main driver there was the fact that most of those activities were with Synfuels and I was living in a Synfuels environment, Synfuels Mining environment. Johan: Why did they bring you onto the team? Clem: Well, the fact of the matter here was that there was a lot of value in this. You know, if you’ve looked at the promised rand values that were in excess for the first year, I think it was approximately R100 million and it was stepped up year-on-year to quite substantial amounts of money. And the promise was made to the Group executive committee in Sasol, our highest level of reporting, and we had to track that very vigorously to ensure that we deliver on the promises that were made. Johan: What model did you decide to use to measure the value? Clem: Well, to ensure that we do capture all the benefit and make sure it adds value to Sasol, we’ve decided on a model called TCO – total cost of ownership – where we’ve looked at direct and indirect cost on a year-to-year basis. You have a baseline and the baseline had to be adjusted for changes, to ensure that when we increase our input, it is captured accordingly. And at the other end there are certain market drivers as well, the indices. You had to allow for what the market indicated. So if you beat that, it shall be measured as a benefit. Johan: You say volume adjustment. Please expand?
99 Clem: We have a certain amount of white product that we push through the Sasol system every year. If we do more of that, the variable cost that is associated to that should be adjusted before you have a proper baseline. If you increase on that unrelated cost, you need to ensure that your model caters for all the variable portions to include that. The same when you increase your throughput and you need to increase your transport in order to deliver the product, you need to cater for the variable cost portion. Johan: What did you do in a case where you establish a new plant or decommission a plant? Clem: In terms of new plants, decommissioned plants, you had to adjust your baseline to reflect that and all the costs what were attached to that had to be removed from the baseline. Johan: Did you experience any problems with the measurement? Clem: There were quite a few things that we had to overcome. I think the biggest here was the availability of data. That was quite a substantial problem. Also, if you look at the financial side, we had not always used the financial information to do the tracking. There was quite some sort of reconciliation that had to be done between the payment cycle and the financial reporting in terms of income statement and balance sheet. It was quite tough in certain instances because many of the tracking that we did, was done purely from payment. If you look at the payment cycle, it doesn’t always fall straight into the income statement. So if you have to compare that side to your income statement, it was a tough task. Certain of those things had to go into your inventory, it went to capital projects, it went into various areas that were not directly related to pure cost on your income statement that you had to adjust to make sure that we do cater for your benefits. Johan, So what you’re saying is that your budget escalation and the true commodity did not add up? Clem, They didn’t tie up. Johan, If I understand correctly, from a TCO measurement point of view, the main issues were the availability of data and systems. Getting the exact data for a specific commodity and tying that back to your financial statements?
100 Clem: I am comfortable with that. Johan: What did you then do to overcome this issue? Clem: What we did is to build an excellent model where we’ve distinguished between your sustainable benefits and once-off benefits. The sustainable benefits were split into idea benefits, price containment benefits and TCO benefits. The fact is we had to make it auditable as well because if you start tracking, you need to have good definition and guidelines to ensure that whatever has been claimed can be audited. For this reason we developed a tracking model. Johan: Clem, if you could forward me that model, I’d appreciate it. Clem: Will do. Johan: The data and availability. So, you developed a new model that you use for tracking of the value release: to cater for the issues or the complexity of establishing a TCO. Clem: Yes, we tested the market to see if specific models were available that you could use and apply. We were unfortunate with that. We had to develop a model where we catered for the tracking, where we then listed all the ideas and in which bucket they would fall from the TCO model. Each team had access to this where they report on a month-to month basis. Johan: But the measurement of those ideas was still in line with the principle of TCO. Clem: Absolutely. I mean that is why I say, in terms of auditing purposes, we had to agree to the rules for each and every benefit reported, whether it was a sustainable idea, the volume adjustments had been done, the correct indices had been used, the direct cost had been taken into account. And, as I said, on an annual basis we involved the Sasol auditors for each of the teams to ensure that they did apply the rules correctly and we got an actual audit report reflecting the correctness of the benefits.
101 Johan: Is it possible to link TCO measurement to your financial statements? Clem: Johan, we went through quite a huge exercise the one year to ensure that this was relevant, especially in the Synfuels and Mining environment and I am comfortable to say that 100 per cent of those have been taken back into the financial statements. The matter of the fact is that all of that will not necessarily reflect on your cost side some of those will be reflected in your balance sheet as well as your cash flow where you build certain plants and where in the depreciation cycle that will be reflected in your costing. In terms of that we had sign-off from our financial side, on the Synfuels as well as the mining cycle, where they’ve actually agreed that the benefits can relate back into your financials. Johan: What do you need to keep in mind when you do the reconciliation between the value released and the financial statements? Clem: You need to consider the market index used, the volume adjustment and the assumptions used in the budget process. The budget does not necessarily use the same index and volume adjustment. Further, do your financial statements also not cater for index adjustment and value adjustment? Our financials are also not inflation-based, and in both cases those are the two elements that you use to adjust your baseline from a TCO point of view. Johan: The value claimed via implementing strategic sourcing; will you say that is a true reflection? Clem: I feel comfortable that it is a true reflection in terms of the ground rules developed. Johan: You referred earlier to the principle of once-off versus sustainable. Can you please define “onceoff” and “sustainable” benefit? Clem: The once-off benefit is not a baseline-related benefit. It is a benefit that happens where there is negotiation, for example in Sasol’s German business many years ago where we had what was referred to a “spot pricing”: when prices were low we’d buy, and as prices went up, we’d sell it again and in terms of that we would claim a benefit. That is not a sustainable benefit.
102 Johan: And that only happens once. Clem: Absolutely! The risk is that you might claim that it is sustainable. You will have to do the adjustments; one year you might have a benefit, but the next year you might have a huge loss. Johan: And the sustainable benefit? Clem: The sustainable benefit is where, year-on-year, the baseline adjustment is done and on an annual basis Sasol has the benefit of the benefit. It will run forever more. Johan: A practical example? Where, for example, a specification changes. Where a certain specification, where in the past you utilised a certain level and in terms of the new product you require far less, but you continue using that further more.
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APPENDIX C TRANSCRIPT OF INTERVIEW WITH MS THIANA BORNMAN
Ms Thiana Bornman interview transcription Interview held on 18 May 2010, Sasol Head Office, Johannesburg
Johan: What is the role of the Procurement Centre of Excellence? Thiana: It is a strategic role where we give direction to the broader procurement community within Sasol. We are also responsible for the procurement governance and training of the procurement fraternity. Johan: What do you do mean with procurement governance? Thiana: Governance with regards to specific procurement policy, procedures, work instructions and so forth and then also the benefits measurement will form part and parcel of that governance. Johan: What will you say is the key elements that need to be in place or what you need to consider before you make that decision to embark on a process of strategic sourcing? Thiana: Johan, to me it is extremely important that you do a spend analysis to fully understand what you are dealing with, what you are buying, where you are buying it from and from whom you are buying. Without a proper spend it will be extremely difficult to make any decision because that to me is the whole foundation of the strategic sourcing process. Johan: Please explain the process that you followed in 2000 in Sasol, to understand the Sasol procurement business?
104 Thiana: With the spend analysis you basically start off with gathering all the spend throughout the Sasol Group and then to build a proper spend database for a specific financial year. This will then form your baseline going forward. Once you have that full spend database, you can then start analysing the spend and categorising it into logical groups in order to understand what you are buying and who are the different Sasol entities buying all these groups and services in that database. Based on that information, you can then make certain decisions in terms of whether it is feasible going for strategic sourcing or how to structure your strategic sourcing environment based on the logical clusters of goods and services. Johan: I take is that this then forms the basis on how you determine the commodities that you would like to focus on. Thiana: That is correct yes. Johan: In Sasol today, what percentage of the spend base are they currently managing from a strategic point of view? Thiana: Johan, it is in the region of 60 per cent of total external spend at the moment and obviously going forward, we would like to achieve at least 70 per cent of the total spend based on strategic sourcing principles. Johan: In my interview with Radie van Wyk, he told me that when Sasol decided to take the route of strategic sourcing, the Group executive approved a potential business case of R400 million of value to be released. Thiana: That is correct. Johan: And there was a lot of time spent in measuring or establishing the ground rules for how to measure this value? Thiana: Yes.
105 Johan: How important is it to measure the value released by a strategic sourcing process? Thiana: Johan, for me it is extremely important to measure, because if you do not measure, you would not know how well or bad you are doing. Apart from that, it is also important for management information that you know how you are doing, what is the value that you are extracting from your external spend and then also it is very important to inform your stakeholders, because strategic sourcing is supported by senior management group-wide in Sasol, and it is extremely important that we inform them on a regular basis in terms of how good we are doing in terms of the targets that we set on an annual basis. Johan: Can you explain the process of measurement of the strategic sourcing value release? Thiana: Here we look at the Sasol Benefits Model. Johan: Can you define benefits and what does that mean in practice? Thiana: Firstly, we categorise benefits in terms of sustainability or once-off benefits. Sustainable benefits are then further categorised into TCO benefits, idea-realised benefits and cost-containment benefits. The main difference between these different types of benefits is to what extent you know the six requirements that we set for this module, to which extent they need all six of those requirements or only a few of those requirements. Johan: Could you please name the requirements? Thiana: The six requirements that we indicate in our benefits model is: we need an index, and economic index. We need a baseline. It must definitely be sustainable. Then we need an activity level. In the case to TCO measurement, we need a TCO tree and then also it must be MECE. MECE just means no gaps or overlaps. Based on these six requirements, if we look at the different types of ideas, TCO for instance; TCO benefits need to adhere to all six requirements. Johan: Can I then regard TCO measurement as the highest level of measurement?
106 Thiana: It is the highest level of measurement, but it is also the most complex. Johan: Yes, that is like when you do TCO measurement, you are right there on top. Thiana: Yes, normally it is a process where you migrate for instance from price containment toward TCO measurement. Johan: What do you mean by “price containment”? Thiana: For price containment for instance, you need an index. You must have a baseline and it must be sustainable. These are the only three requirements that are necessary for price containment benefit measures. Johan: Thiana, how did you derive or develop this model of measurement? Thiana: As far as I understand, when we started off with our measurements, there weren’t any benefits, there weren’t any best practices we could build on and this was developed in-house, fit-for-purpose for our strategic sourcing environment. Johan: Are there any specific limitations to this way of measurement? Thiana: As with everything, there are certain limitations in terms of our current measurement or measuring model, but the benefits by far outweigh the limitations. Some of the limitations currently is that TCO measurement is extremely complex and a lot of effort and back-up information and data is required in order to fully populate that TCO tree and to then quantify it and the opportunity bucket cost elements in itself is also very difficult to quantify. The index is lagging and therefore you will only see the real impact of a change in your economic indices two to three months you know since it happened. As I said the benefits definitely outweigh the limitations. I fully support the measurement, even though there are certain limitations in terms of that. Johan: How much value did Sasol report up to now, since 2000?
107 Thiana: Since 2000 up until financial year 2010 the total benefit reported is in the region of R3 billion and approximately 70 per cent to 75 per cent of that is sustainable. Johan: Thank you.
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APPENDIX D TRANSCRIPT OF INTERVIEW WITH MS CHRISTA-MARIE DU TOIT
Ms Christa-Marie du Toit interview transcription Interview held on 17 May 2010, Sasol Head Office, Johannesburg
Johan: Christa-Marie, can you please state me your name and your position in Sasol. Christa-Marie: My name is Christa-Marie du Toit. I’m the Specialist Commodity Indices, responsible for updating and compiling commodity indices for benefit purposes. Johan: How many years of experience do you have in this field? Christa-Marie: In this field, approximately 11 years. Johan: What is the role of the Centre of Excellence on Indices? Christa-Marie: My primary role is to update on a monthly basis the difference indices, prices, exchange rate that the procurement people use and the commodity people use in their contract price adjustment, as well as in strategic sourcing with regards to the calculation of benefits. How we compare to what the market is doing. Johan: How will you define then the independent index for a specific commodity? Christa-Marie: An independent index would be something that nor Sasol nor the supplier has any control over, so it’s independently published and everybody has access to it. You will go and have a look at your cost drivers of a commodity, see what the relevant importance of each of those cost drivers in your total cost is, get the weights of importance and then you will go and find an independently published index that will measure that cost. With those two elements, the weights and the independent indices that you get, you compile basically a composite index which you call a
109 commodity index with which you can measure the cost movement of your commodity, either up or down. Johan: So in order to estimate an independent index you need to keep in mind your cost drivers of the commodity and then you say you need to find the relevant index. Christa-Marie: Yes, and typically when you work with international indices when you’ve opted for an imported component in your commodity, then you will have to look internationally for their indices and you need to take into account the exchange rate. It will also be part of your formula then. Johan: How do you ensure that you don’t end up with double counting where you compile an index? Like, for instance, certain items that are already captured in PPI, the same cost element may be reflected in another index. Christa-Marie: It’s when you do the calculation of the composite index. You do a mathematical calculation of your formula so that you can isolate the different components and put them together to get one weight from that, that’s not reflected in another portion’s or element’s weight. Johan, Say for instance in a case where a supplier wants to ring-fence a specific cost item like the escalation takes place on a yearly basis and now you want to ring-fence a cost element which you would like to escalate only on a monthly basis. Christa-Marie: When you do that you do it on contract basis and that portion of your formula you will adjust, the rest you will keep fixed. You won’t adjust so it will be multiplied with 1. That is in contract price adjustment. In strategic sourcing or TCO we want to measure what the market is doing and taking a fixed portion into account there won’t be right, because then you won’t see your benefit at the end. You need to take that fixed portion out of the equation and make your weights adding to a hundred percent again to see what the market is doing and then compare that with what you did in your contract price adjustment, you will see the benefit. Johan, Are we actually saying that your contract adjustment versus the measurement of total cost of ownership within strategic sourcing is not equal?
110 Christa-Marie Yes, you will typically take out the fixed portion. Johan: What are the main issues or shortcomings of this method of TCO measurement? Christa-Marie: From the index point, the first one in my mind is you don’t always get the right or the specific index that you want to measure the cost with. That’s the first one. The second one, in these indices, because you want the independently published index some of them lag two or three months or more sometimes and that creates problems because you want up-to-date information. And your suppliers don’t always understand the fact that these indices are measured on a lagging basis. Johan: Okay, so in practice what happens then is, for instance, a supplier comes to you with a specific escalation, for instance labour, his labour cost already went up. But the labour index in itself doesn’t portray the increase. Christa-Marie: Yes, because typically in labour’s case, labour negotiations yearly happens around July, but it always lags a month. Those negotiations can take forever. So the actual index is only adjusted by October/November. But the supplier wants the adjustment already from July and the index won’t reflect that adjustment. Another one typically is table L1 or L2, which is the index for road freight. That index, because it’s a composite index some of its parts are not known up-to-date so that typically will lag two to three months. Johan: Okay, so what you are saying to me is then, from a contract point Sasol may have already granted an increase, but from a TCO measurement point of view the actual index adjustment for the TCO baseline is out of sync. Christa-Marie: Yes, that could easily happen. Johan: So it may look like a de-saving but in the meantime it’s only the market or the index only needs to catch up with the reality with what’s already happened in the market.
111 Christa-Marie: That can happen. What also can happen is sometime indices get revised. So the contract was adjusted to a certain index and the index was revised in the meantime, so the TCO benefit measurement will show something else because the index has been revised. You get that problem as well. Johan: These principles that were developed, have you rolled this out overseas? From a practical point of view, will you say applying this internationally is different to applying it locally? Christa-Marie: I don’t think there’s a difference. The principle stays the same. What you can do here, you can do in Germany. You can do it in the USA, you can do it in Italy. We actually already did that. If you’ve got indices in South Africa, you will get indices or processes or exchange rates in another country as well. Each of these countries publishes these indices and the principle stays the same. So what you can do here, you can do there. When you do it from here onto an international base and you want to convert it back to South Africa, you will always need to take into account the exchange rate that could have an impact on your figures. Johan: How do you go about in Sasol in managing and providing this information to the strategic sourcing environment? Christa-Marie: The Index Centre of Excellence will typically work with the strategic sourcing teams, understanding their commodity, the cost drivers. Then the Index Centre of Excellence will go and compile this formula or this commodity index, this composite index and all of these indices of commodity, of all the strategic sourcing teams then are put together in one model to ultimately get an average market index. To say this is the PPI or the Producer Price Index for a Sasol and you can obviously break that down to just looking at Logistics or Mechanical, a Mechanical index or Electricity and Instrumentation or Process Materials. But it all gets weighed then with spend, the annual spend to get a yearly PPI. Johan: Tell me how many indices do you have? Christa-Marie: Yes, currently we’ve for the Sasol Procurement Index Model. It has about 250 odd commodity indices in there linked to about, I think 100 to 135 different indices.
112 Johan: Is this web-based? Christa-Marie: Yes, on a monthly basis it will be updated and then published on the web for their access. Johan: Now before Sasol embarked on strategic sourcing, what did they use to determine the efficiency and effectiveness of their sourcing? Christa-Marie: That’s difficult to say, probably just budget. By looking at the budget, did we make the budget or not. I don’t think they actually measured, I don’t think they actually measured their efficiency to buy. What they did on contract price is three quotes or they just negotiated, in many instances accepting what the supplier says. Johan: From a sustainability point of view, do you have any specific measures in place to make sure that you don’t lose that value? Christa-Marie: Yes, you need to keep focus and make sure that you’re better than the average on a continuous basis. Johan: The process of establishing an independent index is actually a scientific process and it’s not being influenced on a monthly basis by strategic sourcing people. Christa-Marie: Yes. Obviously you set the index and that will stay the same for at least a year. You can’t change it every month. It doesn’t work like that. Johan: Say for instance something changes, how do you go about it? Christa-Marie: If something is structurally changed, then you need to go and have a look at your index, if it’s relevant or not and then you can change is to become more relevant. Johan: How does the governance process then work?
113 Christa-Marie: He will contact me and I’ll do the analysis to see if that’s really true or not. We will have discussions on why this could have happened and then I will try and compile a new index that they need to take to the Steercom for their approval. Johan: What’s the Steercom? Christa-Marie: The Steercom, is the executive committee that needs to approve these strategies of theirs. Obviously the commodity index and measuring benefits is part of that strategy and they need to sign that off to say this is what happened. There’s the structural change that took place and we need to adjust the index. Johan: And it is also part of your audit process? Christa-Marie: Yes, and obviously you can’t go and change these indices every month. There must be good reason to change that. Johan: Yes, otherwise they can manipulate it up and down. Christa-Marie: Yes, and that’s why we start off by using independent indices that cannot be manipulated by either Sasol or the supplier. Johan: What will you say, what’s the biggest mistake people make in determining that independent index? Christa-Marie: I think don’t go for average PPI. Many companies do that. Johan: The PPI… Christa-Marie: The average PPI. Because we call it the PPI All Groups. It’s the average of the average of the average. Rather try and find as closely-related index as you can get. It can give you a total different picture at the end instead of using the PPI overall index. That’s another thing that we must just
114 remember, we’re working with averages, the industry averages and we need to be better than the average to get the benefit.
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APPENDIX E TRANSCRIPT OF INTERVIEW WITH MR NAAS DU PREEZ
Mr Naas du Preez interview transcription Interview held on 21 May 2010, Sasol Head Office, Johannesburg
Johan: What was the reason for starting with strategic sourcing in Sasol? Naas: At that stage I was Commercial Manager: Optimisation and it really started off with Nereus. What triggered it was obviously cost savings because of economic pressures and I think a company like Sasol must always look at reducing cost. But reducing costs, even from a supply chain point of view and I must state at this stage I don’t think we were aware of the total cost of ownership concept. So at the very first, early stage we just said okay, let’s look at where we can reduce cost, save money from a supply chain point of view. Johan: Can you explain to me then the process that you have followed at that point to establish the potential? Naas: Maybe I should go back. Initially when we said let’s see whether there are opportunities, obviously we looked at the total spend of Sasol and of the different divisions and we didn’t at that early stage go into identifying commodities or commodity groups. That was just the bulk spend as far as I can remember. And then we went out on a RFQ to several consultant groups to say what can you put on the table, and it was really not, you know not the biggest detail in terms of what we expect. But we said what can you come up with in terms of savings and cost reductions? We had discussions with all of them and the feedback was quite interesting. I can still remember the figures that were mentioned by most of them at that stage was R30 million to R50 million and eventually when McKinsey came in, they spoke about R400 million to R800 million. We had long discussions with them and then we started realising, but we’re talking total cost of ownership, which is far from saving money on procurement or what you pay for stuff. We also then realised that they did work at Iscor at that stage, which is now Mittal. And we got representatives from Iscor to come and give us a presentation of their expectation, experience because they had been down that route for quite a
116 while then. And I think that made a major difference in our understanding, also then contributed to the decision to go for the McKinsey’s total cost of ownership and strategic sourcing way. Johan: How did you get internal buy-in for the process? Naas: Initially we had discussions and it was mainly Nereus and I that started off the discussion with McKinsey at that stage. And obviously they then prepared their presentations that actually reflected how they go to work. We then went to the Exco. We had a lot of discussions, one-on-one discussions initially, even up to Peter Cox at that stage, and that took quite a while. We had to work through single individual sessions and then eventually we made a presentation to the Exco and eventually the concept was accepted and it was decided to go ahead. Now you come with a project plan on how you’re going to roll out. Johan: Naas, now what was the original view of the key stakeholders on the possibility of saving R400 million? Naas: I think they were sceptical initially because at that stage the MDs or the GMs still did not understand it, but decided to go for it. It seemed almost impossible, but once we started understanding that you’re looking across functions and that you’re looking at total cost of ownership from a supply chain end user or stakeholder point of view, it became clear that it is possible. So, initially there was, I won’t say resistance, but there was a lot of convincing to be done that it can be done. Johan: So you say it took a while to convince everybody? Naas: Once we had the go-ahead, we actually had to visit each and every head of a business unit at that stage as well as his reportees and again discuss this plan, sorry, explain how we’re going to do it and there was a lot of discussion. I mean it really took a lot of travelling, a lot of time talking to, on the business unit level also with their management structure. And then of course the implication also became clearer because you need people to run this, to run the whole process. And the decision (and I think that was an excellent decision) was taken that we will, each business unit will somehow give people to this process to be part of the value teams or the money teams as they initially were known. But we’ve changed that name because the connotations were not that great.
117 This is a totally different kind of thinking in terms of saving or cost reduction and we will need our people and will need a mixture of people. Johan: Then what were the main issues that you were confronted with when you had worked with the business units and tried to get buy-in for the process? Naas: The one thing that makes or breaks a process like this is whether you’ve got top management support because that is absolutely crucial. If you haven’t got that support, you can forget about it. I think the other point going with that is how do you use or apply that support? Do you use it in a threatening way or do you use it to support your arguments? So the main issues I would really say are to understand the concept of a cross-functional approach to be able to put money in the bank. That was maybe one of the biggest issues to get around and then obviously initially it was quite a problem to convince people that we need people out of the organisation that will be part these value teams, and we started off with fourteen to sixteen weeks. These people would be out of their work, out of their position for that period on a full-time basis. That took a lot of convincing but eventually I must say the people just worked together. So the first value teams we really had to go out and search and I can’t say beg, but let’s say beg. But once we had this traction and we saw there were results, it became easier to get people for that, for the value teams. Johan, What was the process that you followed to determine which commodities to start with? Naas: Well what we did is, and that was the McKinsey contribution, is to interrogate all the spend from all the business units and see where we spend the most money. The typical 80/20 principle: which commodities and where the money went and from that we made a list of about 80 to 100 commodities. That really was where the most money was spent. And then those commodities were actually put into commodity groups. For instance, let’s talk about transport or chemical, processed chemicals. And there were presentations to a steering committee, I should have said that before, that was set up under leadership of Nereus and we had to come and present our case to say these are the commodities and we propose to do this with X, Y and Z. So I think the very first round we started off with seven value teams, if I can remember correctly. But it had to do with the strategic, high-value commodities and what are the TCO potential of these commodities. So those were two of the driving forces to determine what we are going to do, and prioritise these commodities.
118 Johan, How important was measurement? Naas: Measurement, let me just say what happened at that stage; everybody knew we had to measure and there I refer to tracking. When we started we had to verify and prove and put in place how much we’ve actually reduced cost. So initially we had a small team that started looking at how we track what we put on the table. But the further we went it became clear that it is absolutely vital. There’s not even a way that you can think to do this project without measuring the successes or then the failures for that measure. There was actually a team created to set up a tracking system. On it’s own this was quite a challenge because we had to decide and eventually you’ll have to come with a policy to say how do we define cost reduction, a TCO cost reduction and a saving. Everybody had to know how to actually report it. It wasn’t just, you know, slap-dash. You can’t do without it otherwise you cannot even prove that the project has delivered what was supposed to be delivered. Johan: So what you’re saying to me is, as soon as you were allowed to proceed with this new approach, you had to continuously prove the value that’s released and basically your value proposition? Naas: Oh yes. Well I think it’s really slightly even more than that. Obviously this was a growing process, an evolving process. But looking back and having been exposed to other processes, similar processes and if you can see it up front, you need your targets and those targets must be set up front as soon as possible for value teams, for commodity groups and you must track on a regular basis end we did it on a monthly basis, on what was your target, what was your projection and where are you now? And if you’re not on target, why not and what are you going to do to get there? So it becomes almost a non-negotiable once you’ve pegged down your targets. Then you must live up to it and therefore we had a monthly feedback per team, and eventually when the commodity teams were put in place, which was later, they had to report back on a regular basis. Where were they, compared to the targets, what are they doing, how are they going to make it up? Johan: The results at the end, what was the highest level at which this was reported? Naas: The Group executive committee
119 Johan: Measuring total cost of ownership, it’s not so easy? Naas: Yes. Johan: Can you explain to me some of the tools that you have put in place to measure this? Naas: I know specifically that we started at that stage the tracking tool. And every team had access to the tracking tool and the targets were in there and they had to update it on a regular basis, which was monthly. Johan: So my question now is: after you’ve left Sasol, you’ve worked with many companies as a consultant in the area of strategic sourcing. Will you say that the principles and the things that were developed in Sasol are still world-class today? Naas: I still think it is definitely world-class. I’ve seen this now operating in two to three other companies, the whole process. And I think that the major strength is that we realised that we have to go crossfunctional from day one and that we’ve applied and that is working for us. It will be different the second time, because you’ve got hindsight, and you will maybe start a few thing earlier. For instance your tracking system, to get that going as soon as possible. Yet, I also think you have to understand, you have to explore what is in your company, in your business in terms of commodities to be able to put together a tracking tool. You can’t just buy a tracking tool off the shelf. I think it needs to be customised for that process and for the business unit. But in terms of the process, the way we did it, I think it worked very well and I can recommend it. Johan: In your opinion, what is the main things that need to be in place before a company can embark on strategic sourcing? Naas: I want to almost use the word a burning platform. But if there’s a burning platform it comes much more naturally because everybody really wants to understand why you do it and why we do it. So that’s the one thing.
120 Johan: Anything else you would like to add in general? Naas: I think when we started, this whole concept wasn’t that prevalent and I don’t think we knew a lot of. If ever you want to go into something like this now, talk to other companies that have done it, because it has a massive influence on the company itself in terms of the culture, the way you think, the way you do things, obviously on the structure because you are working across borders now. And I mean it’s a physical structure, but also I want to call it a thinking structure. You cannot only think in your own box anymore. As long as you think, you must think company-wide and hopefully globally-wide if you can. So it brings along a massive change to a company if it’s done correctly and I don’t think it’s something that you build in a week or a month or even a year. It takes time, it take a few years to really make it work.
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APPENDIX F TRANSCRIPT OF INTERVIEW WITH MR WIKUS KRITZINGER
Mr. J.L. Kritzinger interview transcription Interview held on 28 June 2010, Sasol Head Office, Johannesburg
Johan: When Sasol made the decision to embark on a process of strategic sourcing, what will you say is the key learnings for Sasol if you look back today? Wikus: Johan, I would say you know we started with strategic sourcing, let’s say, about ten years ago and at that time there was of course a bit of market pressure. We realised that sourcing was at least one of the very important key strategic levers that we can pull to unlock a lot of value and we were very fragmented at the time as far as sourcing is concerned. And at that time we were very much on a basis of almost three-quotes-and-a-buy. You know there was no strategic impetus as far as sourcing was concerned and we appointed a consultant, McKinsey at the time, to bring the concept of strategic sourcing to Sasol and I think the one thing that we have to realise is that, especially with a consultant like McKinsey, you have a guy who brings a lot of strategic thinking into the company. But that’s still got to be made to work. You have to still make this whole strategic concept work. And I think a lot of things, you know if you are thinking about this fragmented approach, you need to get people to work across business units and then that is a big challenge in itself in any company, but specifically Sasol at that time. Even today we’re still very fragmented and to get people to work together is quite a challenge. So first and foremost, it was quite an investment to get McKinsey on board, but then after that you also have to bring people up to speed. You have to actually work across boundaries. You have to invest in a lot of systems because all the stuff that you are doing must be measured. You must invest in people to bring them into a culture of working across boundaries. So if you look at only the investment in your consultant, that’s only a very small portion of investment. The big portion of the investment of course is in the systems and the people and time going forward. And the other thing is, of course, that you should not see this as a project. I think we had a lot of companies which knocked on our doors afterwards which did the same thing, that they saw it as a project and they unlocked a lot of value as we did, right initially but they stopped it at a certain point in time and they just lost the momentum. And all the things and the good thing that they did were lost and we actually sustained that. And that’s where we always in terms of strategic sourcing talk about the sustainable benefit. And there’s effort that goes into sustaining what we have. At this point in time we sustain around
122 about R3.8 billion to R4 billion of benefits and it’s not easy to sustain that. You have to work to sustain that benefit going forward. So it’s not a project. It’s a way of life in the company. Johan: It’s a business process in itself? Wikus: Yes. Johan: Can you recall what was the original amount that you had to pay the consultants and thereafter what did Sasol have to invest in the process? Wikus: In think the original amount to the consultants, of course today it will be a different amount because that was in 2000. That was round about R20 million. And then we spent at least another R100 million in terms of people and systems. Johan: In terms of the Sasol process today of strategic sourcing, what are you good in? Wikus: If you look at the strategic sourcing process you have a sort of tripartite relationship in that you have your supplier, you have your end user and you have your strategic sourcing person. And in that whole thing, I mean the outcome of the strategic sourcing process is of course a sourcing strategy and if you look at the components of a strategic sourcing strategy there’s a lot of stuff that you have to address in that and I can honestly say that we have good strategies as far as all the different commodities are concerned. So if you look at commodity strategy or sourcing strategies for the different commodities, we actually devised good strategies. Part of the strategies of course is the specifications because that comes from the relationship with you end user. You’re in a position to challenge your specification and make sure that we have specifications that support the whole TCO principle. Sometimes you don’t buy the cheapest. I mean you may find that you would like a more expensive commodity to support the TCO and to bring the total cost of ownership down. And that is another thing that we are good at, and then the whole supplier selection process which we refined to such an extent that we can be quite proud. What is however important is that we start to standardise our process which we currently drive through our Functional Excellence process, as well as the issue of 13 ERP systems.
123 Johan: How did the fact that Sasol had implemented strategic sourcing help Sasol in the 2008 global economic crisis? Wikus: We have a very well-known supplier base which we know very well and we have in a lot of cases a strategic relationship with these guys. We have a very detailed spend analysis where we know exactly what we are spending on what. And this gave us the platform to immediately respond and to see to what extent we can lower the baseline of spend over a very short period of time. And that resulted in a year’s time; us lowering our baseline spend with about R 4 billion. Johan: If you read the latest articles, they refer to a balanced scorecard approach for measurement. In terms of procurement, and specifically then strategic sourcing, are you still only sticking to the measurement of the benefits or did you also change that approach? Wikus: The ticket to the dance of strategic sourcing is of course the measurement of the benefits. It will remain a very important part of the measurements. But as far as strategic sourcing is concerned, you have to break that down into all the different DOVs and then you have to agree with all the stakeholders in this strategic sourcing triangle what the DOVs are. The way that we manage this is that it’s been signed off by Steercoms which actually represent all the end users because they are the receivers of the benefit. And then you have to drive and make sure that you achieve you DOVs. Johan, So in a South African context, how big do you believe the Sasol procurement spend is? Wikus: Well you know if you include capital, I mean we are going probably up to a R100 billion per annum in terms of spend and people normally don’t know how much money that it, but that is close to R15 million to R20 million per hour on a 24/7 basis. Now that is a lot of money. I think we will probably be in the top five, if not in the top three in South Africa as far as procurement spend is concerned. Johan, Another thing that’s pointed out in literature is the fact that, when you want to embark on strategic sourcing process, everybody talks about skills and you need new people. What is Sasol’s experience in this regard?
124 Wikus: In terms of people we decided that we would like to do this whole strategic sourcing approach with building our skills in-house so we developed a lot of courses as far as strategic sourcing is concerned, to actually equip our people to learn the skill of strategic sourcing. That is the one thing that we did. Because sourcing is only the other side of the coin from marketing, there’s no sense in having a guy sitting across the table which is a very much lower level as far as sourcing is concerned and you’re pitching against a guy from a supplier which is a very important and high level marketing guy around the table. You have to have these people on par. And so we invested in a lot of development of our own people. We developed with UNISA a curriculum to skill our people up. A lot of people did a degree through UNISA as far as procurement is concerned as one of the majors. And another thing about people, I think, what we should also mention is, that in sourcing I mean, you can have your people highly skilled which we did. But over time people don’t see – they look at the same problem through the same eyes and it’s also beneficial to get your people on rotation basis to get new people looking at the same problem with different eyes. And in doing that, you also release new value from your sourcing activities. Johan: As the general manager for supply chain in Sasol, how do you see the future of procurement and do you see new value being released? Wikus: First and foremost you have to sustain, as we already mentioned, you have to sustain what you have. You shouldn’t see this as a project. So you have to sustain your R3.8 billion that you have. But of course, as I mentioned, look at the same problem with new eyes. And it’s actually quite amazing that every time that you look at your current and existing commodities you release new value and all these things are audited. It’s not pie in the sky type of stuff, so it’s really well-defined benefits that we extract by the sourcing process. So we would like to build further on that. But as we progress and people get more used to the concept of strategic sourcing and also you actually build the creditworthiness of strategic sourcing, which of course, if you apply the same principles you will add more value. So the R3.8 billion to my mind is only a start in term of MRO spend. We can add a lot more as far as that’s concerned just by doing a few things. Our target towards 2012 is to add another R2 billion. Making sure that you bring more spend into the ambit of strategic sourcing by having your people trained well and making sure that they have all the skills. Rotate the people that you look at the same problem with different eyes and that will also release a lot of value. In the end, of course the whole question of capital. And as we all know, TCO, the TCO principle also applies to the capital environment and if you bring capital which we did not do up to now, and that is in the vicinity of R20 billion per annum, into the same ambit as far as strategic sourcing in concerned, there’s a lot more value to be unlocked.
125 Johan: How do you view ethical behaviour within procurement and supply chain? Wikus: Well ethical behaviour as we all know, as far as procurement is concerned, that is probably the one area as far as corporate governance is concerned, where about 70 per cent of all fraud takes place in the ambit of procurement. So I think it’s of utmost importance and non-negotiable to have people with high ethical values to do whatever you need to do in the procurement space. And I’m not talking only about strategic sourcing. Of course strategic sourcing is a very important part of it. But the whole procurement ambit contracting and everything else that goes with procurement, I think ethical values are of the utmost importance. And as you also know, that is also one of the values of Sasol. We have a few values that we look at in the procurement space. It’s actually the problems that we had with competition law and I think we really focus at this point in time throughout the Group, but especially in the procurement environment on training our people in terms of competition law issues, but also in terms of other laws applicable in the procurement space.
doc_291053637.pdf
Strategic sourcing is an institutional procurement process that continuously improves and re-evaluates the purchasing activities of a company. In a production environment, it is often considered one component of supply chain management.
The strategic sourcing value proposition: A Sasol case study
Johannes Crafford
Research report presented in partial fulfilment of the requirements for the degree of Master of Business Administration at the University of Stellenbosch
Supervisor: Prof. F.J. Herbst
Degree of confidentiality: A
December 2010
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Declaration
By submitting this research report electronically, I, Johannes Crafford, declare that the entirety of the work contained herein is my own work, that I am the owner of the copyright thereof (unless to the extent explicitly otherwise stated) and that I have not previously in its entirety or in part submitted it for obtaining any qualification.
J. Crafford
31 August 2010
Copyright © 2010 Stellenbosch University All rights reserved
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Acknowledgements
I would like to express my sincerest gratitude to my family, Gretel, Stephan and Carla, for their unsurpassed support during my last three years of studies. Thank you to Professor Frikkie Herbst for encouraging me to embark on this course of study. As a specialist in the field of marketing, and this study being in the field of procurement, we are continuously searching for ways to improve our functions’ value-add, labour component and integration into the strategic processes of our organisations. Thank you to my employer, Sasol, for its financial support and encouragement from colleagues and seniors to enrol for my Master’s in Business Administration (MBA) studies. I would also like to thank the following people who committed their time to be interviewed on the subject of this research: Radie van Wyk, Clem Swanepoel, Thiana Bornman, Christa-Marie du Toit, Naas du Preez and Wikus Kritzinger. I would also like to express a kind word to Anne-Marie Schutte for typing this report, Karin Becker for the graphical presentations and Carike Taute and Mariette Nortje for proofreading the final report.
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Abstract
The value-add of a functional department in the corporate environment is continuously being challenged. Functions regularly find themselves in a state of restructuring in order to reduce cost structures which speaks volumes about an organisation’s view of its functions. What is however extremely important to take into account, is that functions can in fact add a great deal of value to the business, but before a function can be recognised as a value-adding partner, it needs to transform itself from a traditional transaction-driven service to a strategic value-adding function which contributes to the business on a strategic level. If this does not happen, the function risks becoming redundant, as most transactional activities today are or at least can be executed in an automated manner. Such a transformation is, however, no easy task, and requires a considerable amount of time to be achieved. It further requires substantial investments, enduring commitment from senior management and specific skills to enable a function to operate at a strategic level. Commitment, investments and new skills on the other hand, do not automatically acquire a seat at the boardroom table for such a function and a place must be earned through accurate proof of the functions value-add in the organisation – the difficult task being expressing that value-add in terms of financial numbers. A function that was confronted with the same predicament was the procurement function of Sasol around 1999, during a time when the commodity prices were under severe pressure and the organisation was looking into alternative ways of improving its cost structure. At this point a decision, to shift the focus of the procurement department from a traditional transactional environment to a value-adding business partner, laid the foundation to re-engineer the function into becoming a value-adding strategic function. A decision was taken to implement strategic sourcing in Sasol as the basis for procurement. This decision required substantial investment and the help of consulting firm McKinsey and Company. The Sasol Board were very confident in its decision, and requested continuous feedback on the actual value that was released through implementation of this new process. This required of the procurement function to develop a model by which the value-add of the process could be measured in real terms. The purpose of this study is to investigate the transformation of the procurement function in Sasol from a traditional transactional function to a strategic value-adding business partner by specifically focusing on the function’s ability to prove its value-add to the organisation, and in so doing, gain respect for being a true strategic value-adding function. Key words: Procurement, value-add, strategic sourcing, total cost of ownership, value chain, supply chain
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Table of contents
Declaration Acknowledgements Abstract Table of contents List of tables List of figures List of acronyms and abbreviations CHAPTER 1 INTRODUCTION AND BACKGROUND 1.1 1.2 1.3 1.3.1 1.3.2 1.4 1.4.1 1.4.2 1.4.3 1.5 1.6 INTRODUCTION DEFINITIONS OF KEY CONCEPTS RESEARCH PROBLEM AND OBJECTIVES Research questions Research objectives RESEARCH DESIGN AND METHODOLOGY Overall design Methodology and data collection Approach to data processing and analysis CHAPTER OUTLINE DELIMITATION AND SCOPE OF STUDY ii iii iv v ix x xi 1 1 3 4 4 5 5 5 6 7 7 8
CHAPTER 2 PROCUREMENT AND STRATEGIC SOURCING’S VALUE-ADD: LITERATURE REVIEW 9 2.1 2.2 2.2.1 2.2.2 2.2.3 2.3 2.4 2.5 2.6 2.7 2.8 INTRODUCTION PROCUREMENT IN CONTEXT Procurement and the value chain Procurement and the supply chain Procurement and strategic sourcing IMPORTANCE OF PROCUREMENT TO AN ORGANISATION TOTAL COST OF OWNERSHIP APPROACH TO STRATEGIC SOURCING DIFFERENT LEVELS OF PROCUREMENT OPERATIONS THE MEASUREMENT OF PROCUREMENT VALUE-ADD KEY LEARNINGS CONCLUSION 9 9 9 10 12 13 16 17 20 21 22
CHAPTER 3 CREATING A VALUE-ADDING PROCUREMENT FUNCTION THROUGH THE IMPLEMENTATION OF STRATEGIC SOURCING: THE SASOL CASE 23 3.1 3.2 3.3 INTRODUCTION THE CASE FOR CHANGE PROJECT PHASE 23 23 24
vi 3.3.1 3.3.2 3.3.3 3.4 3.4.1 3.4.2 3.5 3.6 3.7 Structure Identifying the key commodities to focus on The value team process POST-PROJECT PHASE Transformation of the procurement function The current procurement environment in Sasol VALUE ADDED BY STRATEGIC SOURCING IN SASOL Key learnings CONCLUSION 25 26 27 29 30 31 33 34 35
CHAPTER 4 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: TOTAL COST OF OWNERSHIP MODEL 37 4.1 4.2 4.3 4.3.1 4.3.2 4.4 4.4.1 4.4.2 4.4.3 4.4.4 4.5 4.5.1 4.5.2 4.5.3 4.5.4 4.6 4.7 INTRODUCTION TOTAL COST OF OWNERSHIP AS BASIS FOR MEASUREMENT TOTAL COST OF OWNERSHIP BASELINE ADJUSTMENT Market adjustment Activity adjustment 37 38 41 41 46
APPLICATION OF THE TCO MODEL AS A MEASUREMENT TOOL FOR THE VALUE CREATED BY STRATEGIC SOURCING: CRUDE OIL 47 Elements of the Crude Oil TCO model Activity adjustment Market adjustment TCO Comparison PROBLEMS IDENTIFIED WITH TCO MEASUREMENT Linking of benefits to financial statements Availability of data Establishing a market index and activity adjustment Time and resource constraints Key learnings CONCLUSION 47 49 49 51 52 52 53 53 53 54 54
CHAPTER 5 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: SASOL BENEFITS MODEL 55 5.1 5.2 5.2.1 5.2.2 INTRODUCTION BENEFIT CATEGORIES Sustainable versus once-off benefits Five requirements of benefits calculations 55 55 56 58 58 59 59
5.2.2.1 Mutually exclusive, comprehensively exhaustive (MECE) 5.2.2.2 TCO model 5.2.2.3 Activity level
vii 5.2.2.4 Indices 5.2.2.5 Baseline 5.3 5.3.1 5.3.2 5.3.3 5.3.4 5.4 5.4.1 5.4.2 5.4.3 5.4.4 5.5 5.6 6.1 6.2 6.2.1 6.2.2 6.2.3 6.3 6.3.1 BENEFITS MODEL TCO reduction Idea tracking Price containment Once-off SASOL BENEFITS GOVERNANCE PROCESSES Target setting Reporting of benefits Benefits sign-on process Auditing of benefits Key learnings CONCLUSION INTRODUCTION KEY REQUIREMENTS FOR AN EFFECTIVE PROCUREMENT FUNCTION Vision Purpose Value proposition THE HIERARCHY OF AGENDAS FOR THE SASOL PROCUREMENT FUNCTION Foundation 59 59 60 60 61 61 61 62 62 62 63 65 66 66 67 67 67 67 68 69 70 71 71 72 72 72 73 73 73 73 74 74 75 75 75
CHAPTER 6 SUSTAINING A WORLD-CLASS FUNCTION
6.3.1.1 Stakeholder relations 6.3.1.2 Standardised processes 6.3.1.3 Governance 6.3.1.4 Contract management 6.3.1.5 ERP system support 6.3.1.6 Skills development 6.3.2 6.3.3 6.3.4 6.4 6.5 6.6 6.7 Securing of supply Sustain benefits already achieved New benefits DEFINITION OF VICTORY (DOV) STRATEGIC SOURCING AND THE GLOBAL ECONOMIC CRISIS Key learnings CONCLUSION
viii CHAPTER 7 CONCLUSION, KEY INSIGHTS AND RECOMMENDATIONS FOR FUTURE RESEARCH 77 7.1 7.2 7.2.1 7.2.2 7.2.3 7.2.4 7.2.5 7.2.6 7.2.7 7.3 7.4 INTRODUCTION KEY LESSONS LEARNT Procurement can add substantial value to an organisation Strategic sourcing is not a project, but a new business process Effect of the market and activity levels on a commodity Value released can be once-off or sustainable Importance of governance in a strategic sourcing process Total functional value-add important to stay relevant Strategic sourcing creates a platform from which to respond in times of crisis RECOMMENDATIONS FOR FURTHER RESEARCH CONCLUSION 77 78 78 79 79 79 79 79 80 80 80 82 86 98 103 108 115 121
REFERENCES APPENDIX A TRANSCRIPT OF INTERVIEW MR RADIE VAN WYK APPENDIX B TRANSCRIPT OF INTERVIEW WITH MR CLEM SWANEPOEL APPENDIX C TRANSCRIPT OF INTERVIEW WITH MS THIANA BORNMAN APPENDIX D TRANSCRIPT OF INTERVIEW WITH MS CHRISTA-MARIE DU TOIT APPENDIX E TRANSCRIPT OF INTERVIEW WITH MR NAAS DU PREEZ APPENDIX F TRANSCRIPT OF INTERVIEW WITH MR WIKUS KRITZINGER
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List of tables
Table 2.1: Effect of improvement in various areas of the business on the return Table 4.1: Cost elements of Crude Oil TCO model Table 4.2: Percentage change in crude oil price with July 2007 as base Table 4.3: Statistical results of regression analysis Brent Oil and Spot Purchase Table 6.1: Sasol procurement function purpose Table 6.2: Value release to key stakeholders by procurement Table 6.3: Sasol Procurement DOV 13 49 50 51 68 70 74
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List of figures
Figure 2.1: Porter’s Value Chain Figure 2.2: Value chain vs. supply chain Figure 2.3: Percentage impact created by procurement effort Figure 2.4: Evolution of procurement function Figure 2.5: Evolution of procurement at TATA Steel Figure 3.1: Comparison between value team and strategic sourcing teams Figure 3.2: Sasol value team process Figure 3.3: Evolution of Sasol’s procurement function Figure 3.4: Sasol total spend on goods and services 2009 Figure 3.5: Movement in spend for Sasol South Africa Figure 3.6: Value released by strategic sourcing 2000 to 2009 Figure 4.1: The TCO cost buckets Figure 4.2: TCO vs. Total cost of goods and services Figure 4.3: Year-on-year TCO reduction Figure 4.4: TCO baseline adjustment Figure 4.5: PPI movement vs. relevant commodity index for electrical motors in Sasol Figure 4.6: Developing an independent commodity index Figure 4.7: Development of an independent commodity index for electrical motors in Sasol Figure 4.8: Purchasing life cycle cost elements for crude oil Figure 4.9: TCO of crude oil in Sasol July to December 2008 10 11 14 17 19 25 27 31 32 33 34 38 39 40 41 43 44 45 48 48
Figure 4.10: TCO comparison for crude oil in Sasol July to December 2008 vs. July to December 2009 52 Figure 5.1: Classification of benefits in Sasol Figure 5.2: Sustainable benefits illustration Figure 5.3: Once-off benefits illustration Figure 5.4: Five requirements for benefits calculation Figure 5.5: The Sasol Benefits Model Figure 5.6: Benefit sign-on document Figure 6.1: Hierarchy of agendas 56 57 57 58 60 64 71
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List of acronyms and abbreviations
CEO DOV EBIT ERP GM HOA KPI MBA MD MECE NGIS PPI RFP SA SAP SEIFSA TCO UNISA UNSPC chief executive officer definition of victory earnings before interest and taxes enterprise resource planning general manager hierarchy of agendas key performance indicators Master’s (degree) in Business Administration managing director mutually exclusive, comprehensively exhaustive NetGain information system producer price index request for proposal South Africa
Systems Applications and Products (ERP system) Steel and Engineering Industries Federation of South Africa total cost of ownership University of South Africa United Nations Standard Products and Services Code1
CHAPTER 1 INTRODUCTION AND BACKGROUND
1.1 INTRODUCTION
What is the value that a functional department adds to the bottom line of an organisation? This is a question that is continuously asked in the corporate world. The question is put to all functions: human resources, procurement, finance, marketing and academic literature continuously reiterates the value-add of functions as key focus areas. In an organisation, every manager has to build a case to demonstrate why a function is an essentially required part of the corporate strategic processes and prove the unique value that the function adds to the organisation. A particular function, which for many years was seen as a mere service department, is the procurement function. According to Hardt, Reinecke and Spiller (2007: 1), the McKinsey global survey of chief procurement officers suggests that the role of procurement in many organisations has not evolved much beyond the traditional transactional focus: as buyers of materials, components and services. Some procurement functions, however, have attracted the attention of senior management in their organisations, by taking the functions to an elevated level. By means of integrating their activities more closely with those of their internal customers, these procurement functions have gained sustainable cost reduction benefits in areas that were not traditionally the focus areas of procurement. Due to the roller coaster economic environment that many industries have experienced since the late 1990s, executives were forced to re-examine the procurement environment as a source of enhancing an organisation’s competitiveness. In the late 1990s many manufacturers faced the reality of low commodity prices which put tremendous pressure on bottom-line earnings. Then, by the mid 2000s, the world experienced a boom in commodity prices, but the upward trend ended dramatically with the 2008 economic crisis. These realities, combined with the pressures of globalisation, forced organisations to carefully examine their input costs in an effort to become more competitive. The traditional once-off costcutting exercises would not be adequate any more as suppliers alike were faced with the same issues and challenges. The procurement function required re-engineering to become a true value-adding partner in business and this has become one of the top priorities in many organisations today. Transforming a procurement function into a true value-adding partner is however no easy task, and deciding at which level of strategic value-add a function is supposed to operate, is a purposeful
2 decision an organisation needs to take. A further important consideration is the measurement of the value-add by the procurement function as a means of proving its worth to the organisation. In South Africa, Sasol was faced with a particular challenge at the end of the 1990s: very low crude oil prices. Sasol needed to re-engineer its procurement function in order to reduce input costs by R400 million. A decision was made at board level to implement strategic sourcing as a business process in the procurement function. Strategic sourcing focuses on detail strategy formulation for key commodities in order to reduce the total cost of ownership (TCO) of that commodity. Sasol’s chief executive officer (CEO) at the time, Mr Peter Cox, introduced a process in terms of which the whole organisation was re-organised in a way specifically aimed at reducing input costs. This was the burning platform which demanded the re-engineering of the procurement function and validated the introduction of the process of strategic sourcing. The above scenario played out against the background of a very traditional environment in which most of Sasol’s businesses were decentralised and procurement was performed independently by each business unit. This meant that very little economy of skill and scale were applied. Sasol was organised in silos, which meant that maintenance, production and the various functional departments each functioned independently from each other with each silo focusing on its own performance metric. According to Van Wyk (2010), with the implementation of strategic sourcing and the application of the principles of TCO reduction in Sasol, procurement became enabled to break down these silos and in the process leverage the two crucially important levers: economy of skill and economy of scale. The effect thereof was that the company reported R3.8 billion in value (Kritzinger, 2010) realised from the inception of strategic sourcing to date. After its initial success, the business process was also implemented in a European affiliate when Sasol acquired Condea. The procurement function played a fundamental role in the integration of the newly acquired company into the Sasol Group. According to Hardt et al., (2007: 2), procurement’s tactical potential as a cost killer is well known, and in many companies spend on goods and services accounts for more than 70 per cent of the company’s cost structure. Business leaders have realised that any improvement in the procurement activity of an organisation will have a direct impact on the organisation’s bottom line. The result thereof is a change in the way in which the value proposition of procurement is seen. Where the procurement function traditionally offered only price-containment based on the principle of squeezing a supplier for better prices, this framework of sourcing on the other hand, recognises that the value proposition of procurement is limited to only one aspect, namely the price of a commodity. By implementing strategic sourcing as a process with a total cost of ownership (TCO) focus, various other levers now become available to procurement, namely the usage of a commodity by end users, challenging the specifications of a commodity and working closely with a
3 supplier to stay abreast of improvement options. These levers, amongst others, assisted Sasol in achieving the benefits mentioned above. In academic literature, the importance of procurement and strategic sourcing in an organisation is described in great detail, but very little time is spent on the creation of world-class procurement functions and measurement of the value-add that such a strategic focus brings to an organisation. The intent of this study is to analyse the implementation of strategic sourcing in Sasol as a case study, and to develop a framework for consideration when an organisation decides to embark on the implementation of strategic sourcing as a business process. In addition, the research study will attempt to develop a model for measurement of the value-add that procurement as a function brings to an organisation based on what has been developed in the industry and which may fill the above-mentioned lack of information in literature. 1.2 DEFINITIONS OF KEY CONCEPTS
To ensure that this research study is understood by all readers, the following key concepts are defined and clarified below: i) Benefits
This refers to the value released by reduction of the TCO of a commodity, on a year-on-year basis after making provision for the movement in market prices and activity level. It is the difference between base TCO and the current TCO (Sasol, 2010a: 6). ii) Goods and services
Goods and services are used as a collective concept and include utilities, energy, logistics and raw materials. iii) Procurement and purchasing
These words are used interchangeable and refer to the process of acquiring goods and services. iv) Procurement function
The functional department in an organisation responsible for the processes by which goods and services are procured for the organisation (Hugo, Van Rooyen & Badenhorst, 2001: 5). v) Strategic sourcing
This refers to the collaborative and structured process of critically analysing an organisation’s spending and using this information to make business decisions about acquiring commodities and services more effectively and efficiently (Fox, 2006: 1). vi) Total cost of ownership (TCO)
This includes all costs arising from the procurement, utilisation, maintenance and disposal of a product (Schuh, Kromoser, Strohmer, Perez & Triplat, 2008: 181). vii) Total value of ownership
4 This refers to the total value created to the organisation by acquiring a specific commodity and utilising it in the most effective manner (Bhargava, Koch, Pley & Pathak, 2008: 2-3). 1.3 RESEARCH PROBLEM AND OBJECTIVES
The research problem was identified against the background of an ever changing economic environment in which an organisation needs to remain competitive. The procurement function has been identified as one of the primary areas in which management can leverage economies of skill and scale to be more effective, efficient and competitive in the market place. The research study investigates one of the most successful procurement functions in South Africa, namely that of Sasol, to determine the elements required to create a value-adding function through the implementation and facilitation of a strategic sourcing approach. For purposes of this study, specific focus is placed on the framework of decisions for consideration, as well as the actual measurement of the value-add as a product of the process. In order to put everything in context, the Sasol case study is examined from the point where the board of directors made the decision to implement strategic sourcing as a business process, including all the knowledge gained through implementation of the process up to today. Special focus is allocated to the specific measures that were put in place to sustain the value-add that the process offers. 1.3.1 Research questions
In light of the description of the research problem, the primary research question is defined as follows: How do you create a value-adding procurement function in an organisation through the implementation of strategic sourcing and how do you measure the value-add as a product of the process? The following secondary research questions follow from the primary research question to further define the focus of the research: ? ? ? ? ? ? How important is procurement in an organisation? When is it warranted for an organisation to embark on strategic sourcing? How do you establish a business case for strategic sourcing? Who are the role players who ensure that value is being released? What is the framework to consider when a decision on strategic sourcing needs to be taken? What is the role of total cost of ownership in the strategic sourcing process?
5 1.3.2 Research objectives
The objectives of the research study are as follows: ? ? ? ? ? ? Study the theory of procurement and gain insight into the value-add of procurement as a function; Explore the Sasol knowledge gain, acquired through transformation of its procurement function with the implementation of strategic sourcing; Understand the value-add in Sasol as a result of implementing this business process; Plot the theoretical learning against the practical experience and knowledge gained in Sasol; Gain understanding of the factors that must be considered before implementation of strategic sourcing; Gain detailed understanding of the model used in Sasol to measure the value-add of the procurement function. 1.4 1.4.1 RESEARCH DESIGN AND METHODOLOGY Overall design
The research design of this report should be regarded as empirical, and was conducted in the form of a single case study. According to Saunders, Lewis and Thornhill (2007: 137) a case study is a strategy for doing research, which involves an empirical investigation of a particular contemporary phenomenon within its real life context. The re-design of the procurement function in Sasol was used as the case study. The Sasol case study provides a real life example of an organisation that embarked on a process of re-engineering its procurement function and also addresses the issue of measuring the value-add of the newly structured procurement function. Current text books do not provide for this methodology of tracking. The reason for deciding on Sasol as subject of the case study is that it has succeeded in realising more that R3.8 billion in benefits over the last ten years through implementing and executing strategic sourcing as a business process in the organisation. The Sasol procurement function has also been rated by McKinsey and was positioned in the top ten per cent of companies surveyed globally in the last two years. Sasol has agreed to the use of its data and experience.
6 1.4.2 Methodology and data collection
The information for this study was obtained by means of qualitative research. Qualitative data refers to non-numerical data or data that has not been quantified (Saunders et al., 2007: 608). The process of data collection involved primary data collection from internal Sasol reports such as audit reports, strategic workshop presentations, board reports, monthly reports and internal material. Interviews were conducted with key personnel who were involved in the re-engineering of the procurement function during the inception of strategic sourcing, to gain greater insight into the strategic thinking process utilised to embark on this journey and to identify key experiences which were used to create a framework for analysing a proposal to consider the implementation of strategic sourcing as business process. The interviews form an integrated part of the data collection and the following people were identified: i) Radie van Wyk
Mr Van Wyk is currently an independent consultant in the field of strategic sourcing. He was the project leader between 1999 and 2002 when Sasol decided to implement strategic sourcing. Mr Van Wyk played a key role in the establishment of the process within Sasol as well as lobbying with senior management to embark on this process. ii) Clem Swanepoel
Mr Swanepoel was originally a member of Sasol’s finance department, but during the implementation of strategic sourcing in the group, became a member of the project team with specific focus on the measurement of the value-add of strategic sourcing. iii) Thiana Bornman
Ms Bornman manages the Procurement Centre of Excellence in the Sasol Group. She is responsible for procurement governance and adherence to strategic sourcing processes in the Sasol Group. Ms Bornman was a member of the original project team tasked with the implementation of strategic sourcing in Sasol. iv) Christa-Marie du Toit
Ms Du Toit is a subject matter expert who mans the Centre of Excellence for Commodity Indices. She is responsible for the governance with regards to, and establishment of commodity indices which form an integral part of the tracking of the strategic sourcing value proposition in Sasol. v) Naas du Preez
Mr Du Preez is currently an independent consultant in the field of strategic sourcing with clients such as Anglo American, Anglo Platinum and Harmony Gold. Mr Du Preez was the commercial manager at Sasol in 1999 during the initiation of the process. He was later involved in the roll-out of the process to Sasol Europe.
7 vi) Wikus Kritzinger
Mr Kritzinger is currently the Global General Manager for Supply Chain in Sasol. One of his areas of responsibility is the procurement function. The interviews were recorded to ensure that all data is captured and used accurately. All interviews were transcripted and edited. The edited versions were returned to the interviewees for purposes of sign-off on the content thereof. The transcripts of these interviews can be viewed in Appendices A to F. 1.4.3 Approach to data processing and analysis
Handling of data includes a summary of the respective interviews. It includes analysis of the latter against the background of relevant literature in order to answer the research question posed. 1.5 CHAPTER OUTLINE
Chapter 1 focuses on the research problem and objectives as well as the research design and methodology followed. Chapter 2 focuses on the comprehensive literature study with the main focus on the importance of procurement in an organisation and how procurement has evolved over the last 20 years into a true value-adding function. The researcher also focuses on procurement as a key element in the value chain as described by Porter (Business Policy, 2010: 2) and then looks at strategic sourcing as a business process in the procurement function. One of the key concepts of strategic sourcing is the concept of total cost of ownership (TCO), which is explored and proven to be of fundamental importance in strategic sourcing decision making. The researcher also looks at the measurement of value-add in the procurement function and the role that procurement can play as a strategic partner on board level in an organisation. Chapter 3 focuses on the Sasol case study with the intention of aligning the theory developed in Chapter 2, with the practical experience in Sasol. In this chapter, the researcher examines the reasons on which implementation of the process in Sasol was based, the case for change and the business case that was developed which lead to the management decision to embark on implementation thereof in Sasol. In Chapter 3 the researcher tries to answer the secondary research questions of: ? ? ? ? How important is procurement in an organisation? When is it warranted for an organisation to embark on strategic sourcing? How do you establish a business case for strategic sourcing? Who are the role players who ensure that value is being released?
8 The researcher also looks at how the procurement function in Sasol evolved over time compared to the evolution model discussed in Chapter 2. In this chapter the reader is also introduced to the value that the process has yielded for Sasol. Chapter 4 focuses on the measurement of strategic sourcing’s value-add based on the TCO model. In Chapter 5 the principles, as refined by Sasol in order to make the measurement more effective and less time consuming, are discussed. It is also proposed that this model be adopted in academic literature as there is currently no reference in literature on how the value created by strategic sourcing can be measured. Chapter 6 looks at the elements Sasol had to put in place to ensure that the procurement function stays relevant and remains a world-class function, and the building blocks required in order to ensure a sustainable function in the long run. Finally, Chapter 7 summarises the findings and provides recommendations for future research. 1.6 DELIMITATION AND SCOPE OF STUDY
The study is aimed at defining the value contribution a procurement function brings to an organisation by using Sasol as a case study. The focus is concentrated to the case factors for consideration when pondering a decision to implement strategic sourcing as a business process. The actual implementation and change management in an organisation, as well as the restructuring of the procurement function and acquisition of the required skills, are key success factors, but it will not be addressed in this study and may be considered as a possible area for future research.
9
CHAPTER 2 PROCUREMENT AND STRATEGIC SOURCING’S VALUE-ADD: LITERATURE REVIEW
2.1 INTRODUCTION
Four steps to achievement: Plan purposefully. Prepare prayerfully. Proceed positively. Pursue persistently ~William A. Ward. This chapter analyses a comprehensive literature study, focusing on the importance of procurement in an organisation, and how procurement has evolved over the last 20 years into a true value-adding function. The level to which this function has evolved, differs between organisations, mainly due to the fact that an organisation needs to make a purposeful decision about the level at which it would like to see its procurement function operate and the value proposition expected from the function. The researcher investigates Porter’s Value Chain Model (Business Policy, 2010: 1) which includes procurement as one of the nine activities that can create a competitive advantage in an organisation. The researcher also investigates the process of strategic sourcing, its relation to the procurement function and investigates the concept of total cost of ownership (TCO) as an important strategic sourcing decision-making tool. Lastly, the researcher looks at the methodology behind the measurement of the value-add in an organisation by its procurement function. 2.2 PROCUREMENT IN CONTEXT
In academic literature the concepts of value chain, supply chain, procurement and strategic sourcing are being used interchangeably which leads to confusion to the reader. In the next part of the research report the researcher attempts to distinguish between these concepts and defines procurement and strategic sourcing within the context of the broader value chain and supply chain concepts. 2.2.1 Procurement and the value chain
The value chain concept was developed by Porter (1985) in his book “Competitive Advantage” through which he defined “value” as the amount a customer is willing to pay for a product offered by the organisation, and the “value chain” as the nine generic activities within an organisation which work together to create this value to the customer (Feller, Shunk & Callarman, 2006: 1). The idea of the value chain is based on the process flow of inputs, transformation and outputs, and how these activities are carried out, determines the cost of a product and effects profit to the organisation .
10 The value chain activities of Porter (Business Policy, 2010: 2) are split into primary activities and support activities, and the extent to which organisations are able to conduct the activity in a distinct manner will determine the level of competitive advantage of the organisation. Porter’s Value Chain activities are illustrated in Figure 2.1 below, which describes the primary and support activities.
Firm infrastructure Margins Human resource management Technologies Procurement Margins
Support activities
Inbound logistics
Operations
Outbound logistics
Marketing & Sales
Services
Primary activities
Figure 2.1: Porter’s Value Chain Source: Porter, 1985: 37. An organisation can create a competitive advantage for itself by optimally focusing on the nine activities in two ways, namely: by creating a cost advantage for itself or by differentiation (Business Policy, 2010: 2). The cost advantage is achieved by understanding the cost structure and squeezing cost out of the activities. Differentiation is achieved by focusing on those activities where the organisation has a core competency. One of the nine activities which can assist an organisation in achieving a competitive advantage, is procurement. In the model, procurement refers to the function of purchasing and not to the procured inputs itself (Business Policy, 2010: 2). 2.2.2 Procurement and the supply chain
According to Hanna and Newman (2007: 68) supply chain can be defined as “every effort involved in producing and delivering a final product and service, from the supplier’s supplier to the customer’s customer. Supply chain management includes: managing supply and demand, sourcing of raw materials and parts, manufacturing and assembly, warehousing and inventory tracking, order entry and order management, distribution across all channels, and delivery to the customer.”
11 Burt, Dobler and Starling (2003: 7) define the supply chain as follows: “Supply system includes all internal functions plus external suppliers involved in the identification and fulfilment of the needs to materials, equipment and services in an optimised fashion.” Thus, from this definition, it is clear that the supply chain is a system of functions, plus external suppliers, which form an integrated chain in order to service customers. As in the value chain definition of Porter (Business Policy, 2010: 2), procurement again is a vital element in the supply chain definition of Hanna and Newman (2007:68). But is there a difference between the value chain and supply chain concepts, or does procurement play a different role in these concepts? Feller et al. (2006: 4) state that the primary difference between a supply chain and a value chain is a fundamental shift in the focus from the supply base to the customer. Supply chain focuses upstream on integrating supplier and producer processes, while improving efficiency and reducing waste, while value chain focuses downstream on creating value according to the customer’s view of value. Feller et al. (2006: 2) illustrate this principle as follows in Figure 2.2:
Product
Customer Requirements Value Chain
Input Material
Manufacturing
Finished Product
Customer
Supply Chain Product Requirements Customer
Figure 2.2: Value chain vs. supply chain Source: Feller et al., 2006: 4. Procurement can thus be referred to as the function of purchasing of raw materials and other inputs used in the value creation activities (QuickMBA, 2010: 2).
12 According to Hugo et al. (2001: 4-5), a function consists of a group of related activities which are grouped together to achieve a specific objective. The procurement function deals with those activities that have to be performed in order to ensure that suppliers provide an organisation with the right requirements, in the right quantities, at the right time and place, and at the best price. Amor (2010: 1) points out that this well-known definition was adjusted on Wikipedia by changing the best price concept to total cost of ownership, and it reads as follows: “Procurement is the acquisition of goods and/or services at the best possible total cost of ownership, in the right quantity and quality, at the right time, in the right place and from the right source for the direct benefit or use of corporations or individuals.” According to all of the above definitions, procurement has to do with the interaction with a supplier to acquire the goods and services needed to produce the products a customer needs, and which activity, according to Porter (Business Policy, 2010: 3), can render a competitive advantage for an organisation by means of either cost reduction or differentiation. From the above it is clear that the value chain concept is based on creation of value to the customer by providing a product that satisfies its needs, while the supply chain concept refers to the flow of material to produce a product and deliver it to customers as per the Hanna et al. (2007: 68) definition. Hence the conclusion that the concept of value chain is different to that of supply chain, but the role that procurement plays in both environments are the same and therefore falls within the definition according to Hugo et al. (2001: 4 – 5). 2.2.3 Procurement and strategic sourcing
According to Stock and Lambert (2001: 480) the strategic role of a procurement function is to perform sourcing activities in a way that supports the overall strategic objective of an organisation. Procurement can play a key role in the strategic success of an organisation due to the fact that is one of the organisation’s functions that spans beyond company boundaries (Stock et al., 2001: 480). One approach to procurement is strategic sourcing. According to Laxton (2010: 1) strategic sourcing is a business process that evaluates and assesses the procurement activities of a company on an ongoing basis. It is a systematic process focused on getting the maximum value from a cost- , quality- and technology perspective by leveraging the organisation’s buying power. According to Fox (2006: 1): “Strategic sourcing is an collaborative and structured process of critically analysing an organisation’s spending and using this information to make decisions about acquiring commodities and services more effectively and efficiently.”
13 Sasol (2004: 3) defines strategic sourcing as a process that involves a total cost of ownership approach, to the management of key commodities. It can be summarised as a business optimisation process that highlights value-add resulting from constantly looking at better ways of doing things – thus procuring things. According to Laxton (2010: 1) the strategic sourcing process starts with the evaluation of an organisation’s spend base, analysing the supply markets and a detailed cost analysis. These all form part of the intent to generate savings from the sourcing process. 2.3 IMPORTANCE OF PROCUREMENT TO AN ORGANISATION
Procurement plays an important role in most organisations since the procurement of parts, components and raw materials represent between 40 and 60 per cent of a final product’s sales value (Ballou, 2004: 447). The effect thereof is that any small cost contribution gained in the procurement of goods and services can have a great impact on the profits of an organisation. Leenders and Blenkhorn (1998: 8) suggest that in every organisation, public or private, procurement can add substantial value to the bottom line as spend on goods and services accounts for a substantial percentage of the total turnover of any company. Very few companies’ total spend is less than 20 to 30 per cent of turnover. Chapman, Dempsey, Ramsdell and Reopel (1997: 31) confirm this with their view on the subject that the average spend in an organisation on goods and services is in the order of 50 to 80 per cent of turnover and that second to pricing, the reduction of purchasing costs is the most powerful way in which an organisation can improve its bottom line. Based on the experience of the authors, a ten per cent improvement in the cost of goods and services can lead to an increase of up to 22 per cent in the earnings of a company, compared to the only 16 per cent increase by decreasing labour cost. Figure 2.3 illustrates the effect of the ten per cent improvement in the various areas of focus on the company’s bottom line. Table 2.1: Effect of improvement in various areas of the business on the return
10% Improvement Pricing Purchased materials Market share Labour expenses Other expenses Fixed assets Working capital Increase returns by 30% 22% 17% 16% 11% 11% 11%
Source: Chapman et al., 1997: 32.
14 A fact that is clear from the above figures, is that only the pricing strategy for the final product sold can generate more value to an organisation than the procurement of goods and services. It is evident from the above that the percentage spend on goods and services, is a determining factor in the calculation of the potential value-add of a procurement function within an organisation. If there is no substantial spend base, this value proposition does not exist. Bhargava, Koch, Pley and Pathak (2008: 58) illustrate the value-add to a company’s bottom line in Figure 2.3 below:
120
100 100
10
70% - 90% increase in EBIT
17 - 19 7-9 81 - 83 100
80 45 60
Goods & Services
40
20
45
Salaries
0 Turnover EBIT before Procurement effort Spend base TCO reduction Spend after Procurement effort EBIT after Procurement effort Turnover
Assumptions: 10% EBIT Margin 50/50 split between labour cost and goods & services
Figure 2.3: Percentage impact created by procurement effort Source: Adapted from Bhargava et al., 2008: 58. As illustrated in Figure 2.3 above, the potential impact of a seven to nine per cent improvement created by the procurement effort in an organisation, can have a substantial impact on the earnings before interest and tax; possibly as high as 70 to 90 per cent. The procurement effort mentioned is a total cost of ownership (TCO) reduction which is discussed in paragraph 2.4 below. The illustration in Figure 2.3 is based on an organisation with a turnover of 100, with earnings before interest and taxes (EBIT) of ten units. This indicates a spend base of 90 consisting of a 50/50 split between labour cost and cost of goods and services. If the procurement function is now able to achieve a TCO reduction of seven to nine units, the spend will reduce to between 81 and 83 units. Where the turnover remains unchanged, the procurement effect adds seven to nine units directly to the EBIT, thus an increase of 70 to 90 per cent in EBIT.
15 This reflects the value proposition of a procurement function which needs to be leveraged in order to support Porter’s view that procurement can be a value-adding function that creates a competitive advantage for an organisation. Hugo et al. (2001: 10-11) identified that procurement’s importance has grown in most organisations due to the ever-increasing scope of material costs in relation to other cost elements and the need for cost savings. According to Hugo et al. (2001: 10-11) the following are the primary contributory factors in South Africa: i) Inflation: In South Africa this has been a problem since the 1970s and organisations need to continuously focus on their costs in order to stay competitive; ii) iii) Tough competition: Due to global competition, organisations need to have a cost focus; Shortage of requirements: Securing of supply is a constant problem and organisations need to look at substitutes and alternative sources of supply; iv) International characteristics: Supply sources are more global and consequently South Africa and its producers are more exposed to the fluctuating values of monetary units; v) vi) Supply risk: Due to global growth, supply risk is a continuous reality; Price control: Some countries have imposed tariff protection to its local industries which means that, for South African organisations to compete, they need to reduce their cost structure; vii) Technological revolution: Continuous research and development provide new products which may leave others obsolete if the life cycle of the product procured is not managed properly; viii) Stringent quality specifications and controls: The re-use of materials is increasingly in demand and procurement management have to take careful note of this; ix) Development cost: This continues to increase and to ensure successful marketing of products, the procurement department’s input has become a necessity in the development phase of a product, especially with regards to materials input and their functional suitability; x) Inventory costs: Unnecessary inventory ties up capital. Procurement and procurement planning play a crucial role to reduce inventory cost. Keough (1993: 3) identified four barriers which explain why organisations battle to implement strategic sourcing namely: i) Poor information: Most companies can not answer the most basic of questions, such as how much is spent on goods and services; ii) Weak administration: Most procurement functions are overwhelmed by day-to-day procurement activities; iii) Lack of skills: Procurement functions do not invest in the proper strategic skills required to implement strategic sourcing; iv) Low status: The procurement function is not traditionally seen as a career growth environment.
16 2.4 TOTAL COST OF OWNERSHIP APPROACH TO STRATEGIC SOURCING
The total cost of ownership (TCO) approach to strategic sourcing means that when procuring a commodity, the focus is on all the cost elements related to that commodity over its lifetime and the intent of strategic sourcing is to reduce that TCO of the commodity for the company on a year-onyear basis. This is the basis of the value-add resulting from a strategic sourcing process. TCO encompasses all the costs arising from the procurement, utilisation, maintenance and ultimate disposal of a product within a company (Schuh, Kromoser, Strohmer, Perez & Triplat, 2008: 181). Amor (2010: 1) views procurement decisions based on TCO assessments to be more effective than those based on the cost of purchase. Hidden costs always pose a problem over the long term. Ensuring that all costs are included, makes for a better comparison of supplier offerings (Schuh et al., 2008: 181). Through the process of strategic sourcing, the entailed concept includes an identification of all the cost elements, and then, by working closely with the suppliers and end users of the commodity, the development of plans to continuously reduce the TCO of the commodity and by so doing, realise value for the organisation. According to Burt et al. (2003: 160) “TCO should be a permanent concept in every supply management professional’s mind, whether in a service, retail of manufacturing firm.” Burt et al. (2003: 164-170) make a distinction between three components of TCO: i) Acquisition costs
This is the initial cost associated with the procurement of goods and services. It represents the immediate cash outflow and includes costs like purchase price, planning costs, taxes and financing costs. ii) Ownership costs
These are the costs incurred after the purchase of the goods and services, and are associated with the ongoing use of these goods and services. These costs include cost elements like energy usage, downtime, scheduled maintenance, repair and financing cost. iii) Post ownership costs
Post ownership costs include cost elements like salvage- and disposal cost, which is becoming more relevant in practice. Some examples are environmental costs, product liability costs and customer dissatisfaction costs. The concept of TCO is relevant, not only from a cost reduction point of view, but also from a design point of view, especially if the focus is to create a product that has the lowest TCO for the customer. According to Schuh et al. (2008: 182) the TCO strategy can lead to value creation partnerships of which the focus is not exclusively on price reduction. TCO also helps to eliminate activities in the
17 life cycle of goods and services, which do not contribute value. The savings potential through the strategic sourcing process can be more accurately predicted by TCO than by any other means. Schuh et al. (2008: 183) further states that the TCO concept forms an integral part of the strategic sourcing process and no proper sourcing decision can be made in the absence of a properly constructed TCO model. From the available literature it is clear that a procurement function can add extensive value to the organisation, especially if an organisation decides to adopt a strategic sourcing approach to procurement and that strategic sourcing decision is based on a TCO approach. What is also clear, however, is that an organisation needs to make a purposeful choice with regards to the level at which it expects its procurement function to operate, and then make such a decision part of its senior management’s strategic agenda. 2.5 DIFFERENT LEVELS OF PROCUREMENT OPERATIONS
This section investigates the different levels of procurement operations, from which an organisation could choose and make a functional decision about. In the literature there are various models portraying different phases into which a procurement function can evolve over time. All these models start with a typical transactional focus, which evolves over time into a strategic sourcing focus. In this section the focus will be on Keough’s (1993 :1) model which was published in 1993 and the procurement evolution model of TATA Steel which was developed in 2004. According to Keough (1993 :1) there are various stages of evolution in a procurement function. The five stages are described in Figure 2.4 as well as the level of value-add to the organisation and the characteristics of the various stages.
Stages of evolution Valueadd Focus Keep plant running Minimise cost Lower cost by leveraging economies of scale Specification, design, supplier development Strategic supplier selection Serve the factory Lowest unit cost Coordinated procurement Crossfunctional procurement World class supply management
Focus of strategic sourcing
Figure 2.4: Evolution of procurement function Source: Keough, 1993.
18 As a procurement function evolves over time, the value-add of the function increases together with the strategic contribution of the function. What is, however, very important is that an organisation makes a deliberate choice in terms of the level at which it wants its procurement function to operate and then design the function accordingly. This decision will be driven by the nature of the organisation’s spend base, and the size of the spend as a percentage of revenue. An organisation with very little spend on goods and services may decide to focus on serving its operations on a less strategic level because the cost and effort involved in operating at such a higher level does not warrant the return on investment. The five stages in the journey to strategic sourcing as defined by Keough (1993: 2-3) can be described as follows: i) Serve the factory: This is the initial stage of procurement and the function’s main purpose is only to keep operations ongoing. The focus is clerical in nature and one of the key duties is that of expediting purchase orders; ii) Lowest unit cost: As procurement items increase in importance in an organisation’s cost structure, procurement’s responsibility grows in terms of minimising input costs. The focus is now on cost analysis, competitive bidding and negotiations; iii) Coordinated purchasing: As procurement items further increases in importance, there is more pressure to ensure lower costs, coordinated procurement activities across different business units and production sites take shape. This phase is the first step to leverage economies of scale in the procurement environment; iv) Cross-functional purchasing: The main difference between this stage and the previous is the realisation that design, specification and supplier development can have a far greater impact on the value released in the procurement process than negotiations alone. To be effective, the procurement function needs to re-organise itself and leverage the principles of crossfunctional team collaboration to extract optimal value. v) World-class supply management: The last stage recognised by Keough (1993) is that of world-class supplier management where the focus shifts to development of suppliers to become as effective and efficient as the organisation to reduce the total supply chain cost. If the total spend of the organisation represents a substantial portion of the turnover of that organisation, for example 50 per cent, it warrants procurement operating at a level between coordinated procurement and world-class supplier management. It is in circumstances like these that the strategic sourcing process is the most suitable procurement process and where it will deliver optimal value. Burt et al. (2003: 650) declare that strategic sourcing is the key element of a world-class supply chain function.
19 A practical model is that of TATA Steel (2004: 1). Very much based on the principle of Keough (1993: 1), it is more practical and based on the actual experience of TATA Steel since embarking on a strategic sourcing approach in 1999. According to TATA Steel (2004: 1) its procurement function was a very traditional transactiondriven function prior to 1999. Its procurement function limited its focus to price negotiation, with very little in-depth knowledge of the commodities it procured. Over the next few years TATA transformed its procurement function into a knowledge-based, value-adding, professional procurement organisation. TATA’s procurement evolution process is illustrated in Figure 2.5 below.
Integrated Procurement Knowledge based buying Transactional Organisation
• Total Cost of Ownership • Consolidate and leverage volume buy • Skills: Professional, Team building • Style: Cross-functional • Negotiation based buying • Prime motive: avoid stock outs • Skills: Commercial, follow up • Style: Individualistic • Win-win relationship • Value Creation • Co-location Facilities • Life time contracting • Skills: Interpersonal, coaching • Style: Collaborative working
Strategic Sourcing
Prior 1998
1999
2001
2004
Figure 2.5: Evolution of procurement at TATA Steel Source: TATA Steel, 2004: 1. An interesting observation on TATA’s successful transformation is how the concept of TCO was introduced, together with the principle of cross-functional team collaboration as the transactionfocused function transformed into a knowledge-based buying organisation. Thereafter, the function moved into an integrated procurement function, built on value creation and relationship management. When one compares the TATA experience with Keough’s (1993) model, the clear outcome is that TATA progressed into a level of cross-functional procurement, but that world-class supplier management has not been reached yet. In Chapter 3 the status of Sasol’s procurement function is similarly plotted on Keough’s model.
20 2.6 THE MEASUREMENT OF PROCUREMENT VALUE-ADD
The measurement of procurement’s performance is vitally important as procurement functions are playing an increasingly strategic role in many organisations according to Murray (2010: 1). These measures need to portray the procurement function’s efficiency and effectiveness where efficiency refers to the cost of the function and effectiveness to the value-add of the function. Carter (2010: 1) views a balanced scorecard approach as the most effective way of measuring a procurement function’s effectiveness and efficiency, as this approach reviews financial as well as non-financial measurements. This approach considers four perspectives namely: financial, customer, processes and learning. Lindstrom (2010: 1) also supports a balanced scorecard approach, as the key performance indicators (KPIs) assist an organisation’s management in monitoring progress against strategy execution, expected deliverables and the organisation’s maturity. Lindstrom (2010: 1-2) identified the following KPIs to be measured: i) ? ? ? ? ii) Financial Savings realised; Spend managed per employee; Savings generated per employee; and Sourcing strategy maturity. Customer
According to Lindstrom (2010: 2) it is critical for procurement to track customer satisfaction and engagement. A mechanism to conduct such measurements is the utilisation of customer satisfaction surveys. iii) Process
Most procurement functions focus on process improvements to increase efficiency. Cole (2006: 12) identified the following internal KPIs as important measurement indicators for internal processes: ? ? ? Number of new suppliers used; Number of new invoices processed against previous year; and Percentage of automated transactions.
Lindstrom (2010: 3) highlights that supplier performance has a major impact on the efficiency of a procurement function and suggests the following supplier measurement KPIs: ? ? ? ? On time delivery; Supplier rating; Supplier innovation; and Learning and growth.
21 Competent people are one of the critical success factors for a successful procurement function and it is therefore important to track employee skills and competencies for development purposes (Lindstrom, 2010: 3). 2.7 ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? KEY LEARNINGS Procurement is one of the nine generic functions in Porter’s Value Chain Model, which can create a competitive advantage in an organisation. Procurement is about the sourcing of goods and services at the right place, time and TCO and which are used to provide goods and services to customers. Strategic sourcing is a procurement process which can be employed by an organisation to extract value and thereby create a competitive advantage. The value released by a procurement function can directly be added to the EBIT of an organisation. In order to be able to add value, the procurement of goods and services must represent a substantial portion of the cost structure of an organisation. Procurement’s value contribution has increased significantly in South Africa due to an increased focus on the cost structures of organisations. TCO accounts for all direct and related costs of a commodity. Strategic sourcing’s intent is to reduce the TCO of a commodity. No proper sourcing decision can be made in the absence of a proper TCO model. A procurement function can operate at different levels. It is a purposeful, necessary and deliberate decision taken by an organisation to decide on the level of procurement at which it wants to operate. The higher the level of operation, the more important skills become. The higher the level of operation, the bigger the value-add. A balanced scorecard approach is an effective approach to tracking a procurement function’s performance. A balanced scorecard focuses on financial as well as non-financial indicators. Measurement of value-add becomes increasingly important as procurement’s importance grows. In Chapter 6 Sasol’s procurement scorecard is investigated and compared to the theory discussed above.
22 2.8 CONCLUSION
In Porter’s Value Chain Model (Business Policy, 2010: 2), procurement is one of the nine generic activities in an organisation which need to function collaboratively in order to create value to the customer. The extent to which an organisation is able to leverage effectiveness and efficiency of one of these generic activities will contribute substantially to the creation of a competitive advantage for the organisation. The procurement function can support this process by reducing and managing the input costs into the organisation’s operation. Procurement is defined as the sourcing of goods and services at the right place, time and TCO and strategic sourcing is a procurement process that has proven its ability to contribute substantial value-add within an organisation, as well as crafting a competitive advantage for the organisation. The value-add of a procurement function can be directly added to the EBIT of an organisation and in South Africa the focus on procurement as a value-adding partner has increased substantially over the last 20 years. The framework within which strategic sourcing adds value to the organisation is that of total cost of ownership (TCO). No proper sourcing strategy can be developed in the absence of a welldeveloped TCO model. The decision to embark on a process of strategic sourcing is however a deliberate management decision, and can not be implemented by default. Implementation and development of the strategic sourcing process in an organisation requires substantial investment in systems and skills, but such a decision can unlock intrinsic value in the organisation. The last important factor to consider is measurement of a procurement function’s effectiveness and efficiency from a strategic perspective, and for this action all evidence points towards a balanced scorecard being the most effective approach.
23
CHAPTER 3 CREATING A VALUE-ADDING PROCUREMENT FUNCTION THROUGH THE IMPLEMENTATION OF STRATEGIC SOURCING: THE SASOL CASE
3.1 INTRODUCTION
“When ability exceeds ambition, or ambition exceeds ability, the likelihood of success is limited” ~ Ralph Half. This chapter focuses on the way in which Sasol went about implementing strategic sourcing in order to elevate is procurement function to a world-class function, away from a traditional transactional role to a true value-adding strategic function. The intent is to examine to what extent the theory developed in Chapter 2 is aligned with the practical experience in Sasol. The research study investigates how the procurement function in Sasol evolved over time, the case for change and the value realised in the organisation. 3.2 THE CASE FOR CHANGE
According to Van Wyk (2010), the main drive behind Sasol’s decision to implement strategic sourcing in 1999 was the financial pressure the company was under at the time due to the oil price having dropped to around $10 per barrel. Against this background, the CEO at that stage, Mr Peter Cox, was looking at various alternative cost saving methods to help the company weather the storm, when the focus shifted to the procurement function. According to Du Preez (2010) Sasol tested the market for proposals by key consulting houses on alternative methods to reduce input cost. The results, according to Du Preez (2010), were originally not very positive as consultants pitched proposals of which the possible value extraction were in the order of R30 to R40 million. A consultancy firm which was quite new in South Africa at the time, McKinsey & Company, then proposed a process through which it believed a number of between R400 million and R800 million could be achieved by implementing strategic sourcing and applying the principles of TCO, as discussed in paragraph 2.4. As Van Wyk (2010) states, at that stage Iscor had embarked on this process and achieved very positive results. The R400 million to R800 million figure, was based on the estimated spend base in 1999 of around R8 billion and McKinsey projected a benefit of between five and ten per cent on the spend base (Sasol 2000: 6). The potential percentage benefit was based on McKinsey & Company’s benchmarked experience at the time. The organisation received the proposal with scepticism, especially due to the fact that the potential of R800 million that was put forward was, at that stage, more than the nett profit of Sasol (Van Wyk, 2010). Sasol’s management were very reluctant to believe that it was possible to extract value to such an amount, and after a review of the figures a final target was set: R400 million had to be realised over a three-year period. The original drive was to make Sasol more profitable and
24 not necessarily to re-engineer the procurement function and the concepts of TCO and strategic sourcing were rather unknown (Du Preez, 2010). According to Du Preez (2010) the procurement function was equally sceptical about the value proposition presented, but after engaging with McKinsey & Company, they realised that the TCO principles were multifaceted, and not quite as simple as only examining the price of a commodity. Slowly, the realisation started to manifest that such an extraordinary value proposition was indeed possible. This whole change process was facilitated through visits to Iscor Ltd (now Mittal Steel) and other overseas companies who had adopted the same methodology, to learn more about the approach and investigate best practices. According to Du Preez (2010) and Van Wyk (2010), obtaining buy-in was a long and demanding process and various presentations had to be made to the Sasol executive committee under the chairmanship of Mr Peter Cox. Buy-in and support for the process had to be obtained because implementation of the process required substantial investment to be made. An initial number of R20 million was indicated (Van Wyk; 2010), and the total investment over the next four years for training, acquiring the right skills in the organisation, process design and systems development was in the order of R100 million (Kritzinger; 2010). Considering the specific time period of tough economic conditions, requesting an investment of R20 million while unflinchingly trusting the process to deliver R400 million in value, was quite a bold request, and consequently, convincing the rest of the business after the approval process at the Sasol executive committee was yet another long and hard process during which each and every business unit in Sasol’s South African (SA) operations was visited for presentation of the new approach and its impact on each business unit. 3.3 PROJECT PHASE
After the Sasol executive committee approved the implementation of strategic sourcing, a formal project by the name of NetGain was launched to introduce strategic sourcing and principles of TCO to the organisation. The slogan of the project was: “There is always a better way.” (Sasol, 2000: 1) Project NetGain was about the following (Sasol, 2000: 3): ? ? ? Transformation of Sasol’s procurement function to be on the cutting edge of world-class standards on a continuous and sustainable basis. It is an essential catalyst and tool to bring about a meaningful change in the way the Sasol Group manages its materials and services. It functions by means of cross-functional and cross-divisional teams using an internationally established tool.
25 ? Its results improved the bottom line of each business unit in Sasol and therefore also Sasol’s bottom line. 3.3.1 Structure
The project was overseen by a steering committee under the chairmanship of the Group executive member who held the project team accountable for the set target of R400 million. The NetGain project operated by means of two structures namely: a temporary value team structure and a permanent strategic sourcing team structure. The temporary team was a crossfunctional, cross-divisional team that focused on building a TCO model for a specific commodity, and thereafter, through a process of supply market analysis, developed a sourcing strategy for that commodity. Part of the strategy development process included a list of quantified ideas on how to reduce the TCO of the commodity (Sasol, 2000: 3a). These actions were completed by the temporary teams during a twelve-week period, where after the results were handed over to a newly-established permanent structure called the sourcing team, responsible for implementation of the results attained by the value team and management of the commodity on a continuous basis. The principle behind the two structures is explained in Figure 3.1.
Continuous process of value creation by Strategic Sourcing Team Develop Track sourcing performance strategies and set targets
Value Team analysis
Handover to strategic sourcing team
14 week temporary team
Develop TCO model Set savings targets Identify opportunities Develop saving strategy plan implementation
Implement ideas
Identify Opportunities
Figure 3.1: Comparison between value team and strategic sourcing teams Source: Adapted from Sasol 2001: 7.
26 The reasoning behind this approach was the fact that Sasol was, at that stage, organised in silos. Van Wyk (2010) refers to three silos namely: i) ii) iii) Maintenance; Production; and The functional environment of which procurement was one.
Each silo had its own goals and performance criteria and was performing in terms of its own performance metrics without considering the actions of itself or each other, and in doing so actually working against each other in some cases. To accomplish the development of proper sourcing strategies for commodities, the inputs of all concerned stakeholders are required and commodities therefore have to be analysed from a crossfunctional, cross-divisional perspective. It was for this reason, according to Van Wyk (2010), that they started the process with value teams, of which the members were elected from different environments specifically to bring into effect the principle of following a cross-functional, crossdivisional approach. Du Preez (2010) highlights that the people who served on the value teams, as well as the members of the permanent strategic sourcing team structure, form part of a “thinking structure”. You are required to think outside the box, and you need to apply that frame of mind company wide and in many cases, globally. 3.3.2 Identifying the key commodities to focus on
When the process was initiated there was no accurate spot data, and the organisation had little acumen for what exactly was spent on the various commodities (Van Wyk; 2010). With this scenario, against the background of a spend portfolio of over R8 billion in 2000 and the help of McKinsey & Company, the project team started out by building a comprehensive spend base to understand what Sasol spend on the various commodities it procured, with whom they spend and what was actually bought. Thereafter, as Du Preez (2010) calls it, they integrated the spend base and applied the 80/20 principle to determine which commodities to focus on. This decision was based on spend value, and strategic importance of a commodity and the team worked according to the assumption that the commodities with the highest spend would yield the best return. About 100 commodities were identified to focus on, and the value teams were established and organised into waves to address these commodities, a process that was completed by 2005. Van Wyk (2010) explains that the process of building a spend base and identifying the key commodities was extremely difficult due to the fact that there was no standardisation in the Group and different business units procured the same commodities, but with varying descriptions, from the same suppliers in many cases. On a consolidated basis, Sasol could not aggregate this spend and thereby leverage the economies of skill and scale. It required investment in a process of
27 standardising the descriptions of the commodities that were bought and as a solution, they opted for the United Nations Standard Products and Services Code (UNSPC) naming convention (Van Wyk, 2010). 3.3.3 The value team process
The value team process was a standard 14-week process, followed for each of the identified commodities. The process consisted of four distinct phases namely: i) ii) iii) iv) Building a fact base and setting of targets; Development of strategy and ideas; Implementation; Handover to strategic sourcing team.
The process is illustrated in Figure 3.2. The value team process, and each of the phases are thereafter discussed in detail. The value team process forms the basis of the strategic sourcing process to this day.
Build the fact base and set targets
Develop ideas and strategy
Initiate implementation
Handover
Weeks 1 – 2 Develop a team plan Review previous/ ongoing efforts, baseline spend, and inventory Calculate TCO and understand TCO levers Understand the supply market Finalise team targets
Weeks 3 – 7 Hold stakeholder workshop Generate TCO savings ideas Evaluate TCO savings ideas Develop commodity strategy Send out requests for proposal (RFPs)
Weeks 4 – 12 Set up draft action plans Soundboard & refine action plans with stakeholders Get sign-offs from stakeholders Implement quick wins Develop tracking tools Manage ideas in the NetGain Idea System
Weeks 10 – 12 Set up generic action plans for ideas not pursued yet Soundboard generic action plans with stakeholders Transfer ideas individually to new commodity team Prepare sign-over documents Hold formal sign-over meeting
Figure 3.2: Sasol value team process Source: Sasol, 2000: 6d.
28 i) Building the fact base and setting of targets
This phase consists of the gathering of data across the various Sasol business units in order to understand the spend patterns of the business and the various specifications between the different business units. The analytical tools that are used are detail spend and inventory analysis, supplier economics, industry cost curve analysis and the TCO model (Sasol 2001: 25). A key deliverable during this phase is the TCO model (which is discussed in more detail in Chapter 4). The developed TCO model is used as the baseline TCO for the commodity against which all future improvements are measured. At the end of this phase, the team has a good understanding of the supply market, as well as the internal usage and requirements of the end users. During this phase the team members mostly engaged intensively with all stakeholders, but with specific focus on end users, to obtain the necessary information (Sasol, 2001: 25). ii) Develop ideas and sourcing strategies
This is a very critical phase in the process, for it is during this phase that a sourcing strategy is developed and the team performs a rigorous process of generating ideas to reduce the TCO of the commodity. The ideas are obtained by involving key end users, industry experts, suppliers and other stakeholders (Sasol 2001: 31). Various methods are employed to generate ideas and the team facilitator plays a critical role here. According to McKinsey & Company (Sasol, 2001: 34), five per cent of all ideas are commercial, 20 per cent are provided by end users mostly based on consumption and 10 per cent of all ideas are provided by suppliers. Suppliers are usually in a good position to assist in identifying the correct material specifications. The ideas are then quantified and together with the information gathered in phase one, a proper sourcing strategy is developed and presented to the project steering committee for approval. Sasol learned the importance of end user support very early in the process, and therefore all ideas were presented to the end users as well for agreement and sign-off (Du Preez, 2010). Another deliverable during this phase is the issuing of a request for proposal (RFP) to the market in order to obtain more ideas and inputs into the sourcing strategy. iii) Initiate implementation
The next phase is focused on the development of a detailed action and implementation plan, and the finalisation of all the ideas to be implemented. Quick wins are implemented immediately and the key performance indicators (KPIs) are defined (Sasol, 2001: 82).
29 iv) The handover
The final stage is the handover of the sourcing plan together with the detailed fact pack to the strategic sourcing team who now takes full ownership of the set targets and whose performance is measured against those targets. The whole process is driven by a continuous process of stakeholder involvement and communication of further ideas to stakeholders. All of the above takes place within an ethical framework which is captured in the cardinal rules of Sasol’s procurement practice (Sasol, 2001: 75). ? Sasol conducts all business in accordance with its mission:
“Sasol believes in the free enterprise system … and we insist on the highest ethical standards … and will not tolerate or condone illegal acts of employees.” ? ? ? ? ? ? 3.4 Procurement & Supply have co-responsibility for ensuring adherence to the Sasol rules. Sasol technology and business transactions are confidential and should not be divulged to third parties. Different departments should be involved to ensure adequate cross controls. All forms of dishonesty such as bribery, over-invoicing, fraud, embezzlement will be handed over to the police for investigation. All Sasol agents have to comply with all commercial rules and practices. If in doubt, do not improvise, but discuss. POST-PROJECT PHASE
One of the biggest mistakes, according to Kritzinger (2010), many organisations make when implementing strategic sourcing, is that they see it as a project with a start and end date. They conclude a diagnostic phase and set targets for value to be released, but as soon as that value has been realised the initiative comes to an end and the function starts to move back into its historical role of being only a service function. As a result, the value that has been released erodes as sustaining of the value is as complex as it was at first to realise it. Important to remember is that this is a process of continuous improvement which is only kickstarted with a project phase (Van Wyk, 2010). As soon as the project is complete, new business processes must be entrenched and senior management must continue to hold the function accountable for a continuous stream of new value-add (Kritzinger, 2010). To ensure such an outcome, Sasol had intentionally decided to discontinue the use of the word NetGain after completion of the NetGain project phase and established a formal strategic sourcing structure to which the project results were handed over, and which became responsible for further improvement. This structure is still managed and annually measured against set targets in terms of a set of key performance indicators which are discussed in Chapter 6 (Kritzinger, 2010).
30 The current structure consists of nine strategic sourcing teams addressing 55 per cent of the total Sasol SA spend, and a set target to increase its spend management portfolio to 75 per cent by 2012 (Du Toit, 2010b: 17). Formal governance has also been put in place to govern the business processes as well as the measurement of the value released, which is audited on an annual basis (Sasol, 2010a) and (Sasol, 2010b). 3.4.1 Transformation of the procurement function
In Chapter 2, paragraph 2.5 the transformation of a procurement function was discussed in great detail. According to Keough (1993) there are various stages of evolution of the procurement function. The purpose of this section is to explore the way in which the procurement function in Sasol evolved over the last ten years. Van Wyk (2010) explained that the procurement function in Sasol had the following characteristics before the process to implement strategic sourcing was started, namely: ? ? ? ? ? Decentralised, with no aggregation of spend; No real knowledge of how much was spent; No leverage of economies of skill and scale; No value proposition; No strategic focus or agenda.
Du Toit (2010a) describes the environment as a typical three-bids-and-a-buy environment where the procurement function basically only executed tasks in accordance with the needs of the end users. Now, when comparing these characteristics with Keough’s (1993: 1) model, it typically places Sasol between a service to the factory, and lowest unit cost focused type of procurement function around 2000. The model further indicates that the true value-add to the organisation is very low with this type of approach and thus very little value is added.
31
Stages of evolution High Value-add Low Focus Keep plant running Minimise cost Lower cost by leveraging economies of scale Specification resign supplier development Strategic supplier selection Serve the factory Lowest unit cost Co-ordinated procurement Cross-function procurement World-class supply measurement
Sasol’s position
1999
2010
Figure 3.3: Evolution of Sasol’s procurement function Source: Adapted from Keough, 1993: 2. As illustrated in Figure 3.3, Sasol can today be plotted on the brink between cross-function procurement and world-class supply management as described by Keough (1993). Kritzinger (2010) describes how there is a strong focus on specific key strategic commodities in Sasol today, and strategic sourcing teams are continuously looking at new ideas such as challenging of specifications and supplier development. The process of strategic supplier selection is not yet wellentrenched despite small pieces of evidence to excellent results in areas where it has been applied in Sasol. Thus, as from the time of making the decision to embark on the strategic sourcing journey, up to today, the procurement function in Sasol were able to elevate its value-adding contribution from a mere service department to a value-adding business partner which is very much in line with the model of Keough (1993) in the early 1990s and which is proven to still be relevant today. What Keough (1993) was not able to describe, is the journey of an organisation to enable it to move up this curve and it is for this reason that the Sasol case study has such high value. 3.4.2 The current procurement environment in Sasol
Since the inception of strategic sourcing in 1999, Sasol was able to establish a sustained, highly skilled strategic sourcing structure. The procurement landscape has drastically changed since then due to mergers and organic growth of the organisation. Sasol’s total spend today, is illustrated in Figure 3.4 and the spend accounts for more that 54 per cent of turnover which makes procurement the second most important lever in Sasol to improve productivity as described in Table 2.1. With a spend base of R74 billion, Sasol is also under the top five procurement functions of its size in South Africa (Kritzinger, 2010).
32
137,836 30,911
16,643 4,558 3,611
7,804 74,309 12,577 1,342 558 59,832
TURNOVER AS PER GROUP INCOME STATEMENT
EBITDA
INTERNAL LABOUR
NON-PROC ITEMS*
FUEL SWAPS
COST OF STOCK
TOTAL SPEND FY09
CRUDE OIL
FUEL IMPORTS
EXTERNAL COAL PURCHASES
EXTERNAL SPEND FY09
Figure 3.4: Sasol total spend on goods and services 2009 Source: Du Toit, 2010b. Figure 3.4 illustrates the total spend as derived from Sasol’s financial statement. The reason for ring-fencing crude oil and fuel imports, is the absolute magnitude of spend in this particular area and the strategic importance thereof. This commodity is managed on the principles of strategic sourcing and the concept of TCO, which is illustrated in Chapter 4 by using crude oil as an example. The R74 billion includes Sasol’s global spend and the South African portion of the spend, but excludes crude oil for 2009 which was R23 billion (Du Toit, 2010b: 18). Du Toit (2010a) further describes how one of the key measurements to track the performance of the strategic sourcing process on an annual basis, is to analyse the annual movement in spend and to observe the effect of activity changes, market changes and strategic sourcing improvements thereon. Figure 3.5 illustrates this measurement for 2009 as well as the contribution of strategic sourcing compared to 2008. As per the annotation, the total spend in 2008 was R18 billion. The effect of a decrease in activity on spend on goods and services was R1.1 billion, and was mainly due to the economic crisis while the market inflation on the basket of commodities procured by Sasol had a R2.7 billion negative effect on the spend base. This is calculated based on the movement in all the market indices which have an effect on the Sasol spend base. The actual calculation is discussed in Chapter 4. The effect provides for an adjusted baseline for 2008 of R20 billion.
33
4,002 20,175 (644)
23534
2,667 2,095 2135 14,811 (86) 17,032 (514) 18,613 (1,104)
Total spend FY07
Activity adj: (0.6% )
Market adj: 14.33%
Adjusted Baseline
TCOR FY08
Increase / Decrease
Total Spend FY08
Activity adj: (5.9)%
Market adj: 15.23%
Adjusted Baseline
TCOR FY09
Increase / Decrease
Total Spend FY09
Figure 3.5: Movement in spend for Sasol South Africa Source: Du Toit 2010b: 17. The strategic sourcing contribution for the year was R0.64 billion but there is still an additional increase of R4 billion. One of the effects of having a strategic procurement focus, and part of the function’s value proposition, is the ability to explain movements and changes in the spend base to senior management. According to Du Toit (2010a), the R4 billion increase can be explained as follows: R2 billion was due to a new plant which came into operation and R2 billion was due to abnormal maintenance. 3.5 VALUE ADDED BY STRATEGIC SOURCING IN SASOL
According to Kritzinger (2010) more than R3.8 billion in value has been released by the strategic sourcing process in Sasol since 2000. The annual contribution, as reported by the teams, is shown in Figure 3.6. These numbers are audited on an annual basis, and all teams are held accountable for accurate tracking and reporting of the numbers as well as the sustainability of these numbers (Swanepoel, 2010).
34
645
3,883
513
372 232 388 382 483 389 378 103
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
Total
Figure 3.6: Value released by strategic sourcing 2000 to 2009 Source: Bornman, 2010b. What is interesting to note, is the consistently growing contributions when compared on an annual basis. Also, when you compare this data with the initial forecast by McKinsey of R400 million, one sees that the average contribution over the ten years is R388 million per annum, which is very close to the R400 million originally forecasted. Besides the fact that this is a major contribution to the organisation, these numbers also prove the aspect of sustained continuous improvement. If strategic sourcing was treated only as a project, the project would have achieved its goals in 2001/2002 and the rest of the value-add would have been lost to the organisation. This brings us to the important aspect of “how” to measure this value release. Sasol spent a great deal of time on the development of a set of ground rules which explicitly prescribes the way in which to measure this value. Chapter 4 and 5 focus on how to measure the value released. 3.6 ? ? ? ? KEY LEARNINGS The potential benefit after implementation of strategic sourcing is between five and ten per cent of total spend. Change management is a major element for success. The company needs a burning platform to launch this initiative. The company must invest in skills development, technology support and business process development.
35 ? ? ? ? ? ? ? ? ? ? ? ? ? ? 3.7 When implementing strategic sourcing, a duel structure helps to create the inputs required to get the process going. A formal project needs to be launched – this is not business as usual. Identifying the key commodities may be a difficult process – do not expect that the spend pattern is known. End users, suppliers and procurement’s commitments are critical to the success of the process. Do not see strategic sourcing as a project, but as a new business process. It is not a quick fix, but a long-term commitment. Senior management’s constant commitment is a crucial requirement. Formal governance for the process must be put into place. Procurement is the custodian of the spend base on goods and services. Procurement needs to understand the effect of activity and market changes on the spend base. Strategic sourcing needs to be able to prove its value-add in terms of total spend. Procurement needs to analyse and explain the effect on spend in terms of other strategic decisions made by the organisation. Strategic sourcing is a continuous improvement process. Strategic sourcing can add a substantial amount of value to an organisation over time. CONCLUSION
When an organisation decides to embark on a process of implementing strategic sourcing, a potential benefit of between five and ten per cent of value released from the total spend base is possible. This is, however, not an easy process to implement and the Sasol case study suggests that the best way to approach such an implementation, is to start with a formal project, based on a sound business case. For the project to be a success, the organisation definitely needs to attain its best available skills, and secure senior management support for the project. Due to the wide reach of the process, change management is of absolute importance because this is a process that breaks down silos within an organisation, and completely transforms the traditional approach to procurement in order to extract the optimal value from a total cost of ownership perspective. The project must focus on key commodities in order to extract the optimal value and a formal process needs to be followed by a dedicated team to identify the key commodities to focus on. Yet it is important that the project phase comes to an end and that the new process becomes an official and embedded business process in the organisation to derive a sustained and continuous stream of value to the organisation.
36 The Sasol case study has also proved the theory of Keough (1993: 1-8) in terms of the different stages of evolution of a procurement function and the true value that an organisation can expect depending on the stage that it is operating in. To sustain this value is very important, and Sasol has showed that a formal governance process needs to support a strategic sourcing process to ensure success. The value released by the process is significant, which also supports the view of Chapman et al. (1997: 32) that the purchasing of goods and services is the second most important lever, by which an organisation can extract value and improve its bottom line. The Sasol case has proven this value of procurement, but it also proved that the measurement of the value unlocked through the process is no easy task. The next two chapters focus on this aspect of the process.
37
CHAPTER 4 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: TOTAL COST OF OWNERSHIP MODEL
4.1 INTRODUCTION
“To measure is to know” and “when you can measure what you are speaking about, and can express it in numbers, you know something about it; but if you cannot express it in numbers, then your knowledge is of meagre and unsatisfactory kind.” Lord Kelvin 18th Century (De Souza, 2007). Three centuries later, the case of measuring the value creation of strategic sourcing in an organisation is just as important as measurement was to Lord Kelvin. Measurement of value released, lays the foundation to ensure that the value-add promised in the business case to request the substantial investments required to make implementation of strategic sourcing a reality, is indeed realised. If not, corrective action can be taken, but it needs to be done timeously. Measurement is also critical to ensure that the value released is sustained over time and that unnecessary and eliminated costs do not creep back into the cost structure of an organisation (Van Wyk, 2010). When Sasol decided to implement strategic sourcing in 1999, it was during a time when global commodity prices were severely depressed (Van Wyk, 2010) and the organisation was forced into a situation where it needed to focus on its cost structure, as spend on goods and services accounted for more than 60 per cent of its turnover and it was critical to focus on input costs. Senior management engaged with McKinsey & Co. to implement strategic sourcing as the vehicle to focus on input cost. A project called NetGain was launched to implement strategic sourcing throughout the Sasol Group with the goal to extract R400 million in value. There was quite some scepticism about the promise to extract R400 million as various other consultants at that stage indicated that the potential value release would be in the region of R35 million. It was thus very important to the Sasol Board that the actual value released had to be tracked, measured and reported on a continuous basis. At a later stage it also became important to ensure that the value released was sustained, and where leakages occurred, those leakages were captured and corrective action was taken (Swanepoel, 2010). The key question was, however, how do you track the value created by strategic sourcing by applying the TCO principle?
38 4.2 TOTAL COST OF OWNERSHIP AS BASIS FOR MEASUREMENT
As already explained in Chapter 2, the TCO of a commodity consists of all the costs directly and indirectly associated with that commodity. Sasol decided to adopt this approach of strategic sourcing. The R400 million target for value release was based on the reduction of TCO of the various commodities procured by Sasol. As to how the actual measurement of this value release was to be done, however, was unknown, and no guidelines were available at that stage which meant that Sasol had to create its own set of rules and measurement methodology to measure the value released (Du Preez, 2010). In Sasol, the TCO of a commodity is summarised in four buckets namely: direct cost + internal cost + related cost + opportunity cost related to the commodity in question. This is illustrated in Figure 4.1.
12 0
5 10 0 5 80 80 10
10 0
60
40
20
0 D i r e c t C o st I ndi r e c t C o st R e l a t e d C ost Op por t uni t y C ost TC O Ye a r 1
Figure 4.1: The TCO cost buckets Source: Sasol, 2004: 36. These cost buckets, represent the grouping of the various TCO cost elements into the four main buckets. The four cost buckets can be described as follows Sasol (2004: 37): i) Direct cost bucket
This bucket represents the initial purchase or lease cost which is determined by multiplying the purchase price by the annual volumes purchased. In order to calculate the direct cost it is important to have accurate purchase data and administrative records.
39 ii) Related cost bucket
These are the costs of associated items and activities which are necessary when making use of a specific commodity. Examples include certain maintenance contracts from suppliers, spare systems, spare parts, specialist contractors and even unique packaging that is required. iii) Internal cost bucket
These are the costs that a company needs to incur in order to own a commodity. This is typical the labour cost of people who maintain or install the commodity purchased. iv) Opportunity cost bucket
These costs refer to costs associated with the cost of an opportunity due to the commodity not performing or not being available. The decision to implement the TCO approach of strategic sourcing means that value can be released by focusing on all four cost buckets, and in so doing, reduce the input cost of Sasol. The principle point of departure is, if one adds the TCO of all commodities procured by an organisation, together with the exception of the opportunity bucket and labour cost, it will add up to the total spend of an organisation less labour (Crafford, 2003: 2). This principle can be explained as follows: TCO1 = Direct Cost1 + Related Cost1 + Internal cost1 + Opportunity Cost1 TCO2 = Direct Cost2 + Related Cost2 + Internal Cost2 + Opportunity Cost2 TCO3 = Direct Cost3 + Related Cost3 + Internal Cost3 + Opportunity Cost3 TCOn = Direct Costn + Related Costn + Internal Costn + Opportunity Costn = Total Direct Cost + Total Related Cost + Total Internal Cost
= Total Cost of Goods and Services + Labour Elements
Figure 4.2: TCO vs. Total cost of goods and services For Sasol, it was decided that, to reduce the TCO of a commodity on an annual basis, would be the simplest form of value release in terms of strategic sourcing to implement.
40
12 0
10 0 10 0
20
80 80
60
40
20
0 TCO Ye a r 1 Be ne f i t s TCO Ye a r 2
Figure 4.3: Year-on-year TCO reduction In Figure 4.3 above, the value released year-on-year is illustrated as 20 units. In Sasol, this is referred to as benefits (Bornman, 2010a) and is reported to the Sasol Board as such. However, significant procurement inefficiencies may go undetected if only the nominal amounts expended are compared year-on-year and the reverse is also true. While strategic sourcing may be generating extensive value on the one hand, its performance may be overshadowed by an increase in volumes purchased as a result of growth in the organisation or due to movements in macro-economic factors such as inflation and exchange rates. So in order to obtain a more accurate view of the strategic sourcing performance, according to Joubert, Kritzinger and Crafford (2004: 2), the nominal year-on-year TCO baseline value must be adjusted to neutralise the effect of variables such as: ? ? Activity changes as a result of factors such as growth (capital projects) or activity decreases (plants closing down); Changes in macro-economic factors such as inflation, exchange rates and relevant commodity prices such as steel prices and crude oil prices. The extent, to which the nominal expenditure is adjusted to determine a comparable baseline for a particular year, should be carefully scrutinised and must be subject to governance. The formal governance of the process is critical to the integrity of the value reported as well as the integrity of the strategic sourcing process as a whole (Swanepoel, 2010). In the case of Sasol, these rules are formally governed by official governance procedure on the subject namely Procedure 001: Ground Rules For Benefits Calculation, as approved in December 2009 (Sasol, 2010a).
41 The adjustment of the TCO is explained in Figure 4.4, which illustrates how the baseline is adjusted to make provision for changes in activity levels and market environment changes.
12 0
10 0 10 0
2
3
1
96
16
80 80
60
40
20
0 T C O Ye a r 1 Market A d j u st m e n t Act ivit y A d j u st m e n t New P r oduc t i on C a pa c i t y A d j u st e d B a se l i n e Be ne f i t s T C O Ye a r 2
Figure 4.4: TCO baseline adjustment Source: Adapted from Joubert et al., 2004: 3. When the hypothetical example illustrated in Figure 4.3 and 4.4 is considered, one sees how the actual value released, which is referred to as benefits, decreased from 20 units in Figure 4.3 to 16 units in Figure 4.4, after making provision for market and activity adjustments. The adjustment of the TCO baseline is now analysed in greater detail as this forms such an integral part of the measurement process. 4.3 TOTAL COST OF OWNERSHIP BASELINE ADJUSTMENT
As already explained, there are three types of adjustments to the baseline which are now discussed in detail. 4.3.1 Market adjustment
The escalation or de-escalation from the actual procurement expenditure to determine the baseline for a given year, other than activity changes, is determined by factors influencing the price of goods and services procured. Escalation/de-escalation of indices are based on recognised official indices, based on an official published index of independent organisations such as Statistics South Africa or Steel and Engineering Industries Federation of South Africa (SEIFSA) (Joubert et al., 2004: 3).
42 This is considered to be the most important adjustment in Sasol and is again governed by a formal governance procedure by the name of Procedure 002: TCO price adjustment as approved in December 2009 (Sasol, 2010a). Sasol further established a dedicated Centre of Excellence for commodity indices, which is responsible for updating and compiling the commodity indices for TCO adjustment and benefits trading. According to Du Toit (2010a) who heads this Centre of Excellence, there are more than 250 commodity indices in the Sasol Procurement Index Model which is used for benefits calculation. A commodity index can be defined as an independent index that neither Sasol, nor the supplier has any control over. It has to be published independently and everybody has the right to access it (Du Toit, 2010a). In order to develop an appropriate independent index for a specific commodity TCO, one needs to determine the relevant cost drivers of that commodity, then establish the applicable importance of each cost driver and then find an independently published index in terms of each cost driver (Du Toit, 2010a). Finding the correct index can be a challenge, especially where there is an imported component to a commodity. In such a case, one will have to look at international indices as well as take into account the exchange rate (Du Toit, 2010a). The calculation of this index is independently done by the Centre of Excellence in Sasol in order to ensure that proper governance is applied and that a strategic sourcing team does not manipulate indices in its favour in order to report more benefits. According to Du Toit (2010a), the establishment of these principles can be regarded as a best practice since many companies, to this day, still measure the success of procurement’s effort on the principle of a three quote system where the difference between the highest quote and final paid price is regarded as the value released by the procurement department. Other companies, such as Sasol before the implementation of strategic sourcing, measured procurement activities against the general producer price index (PPI) and where annual price increases were below PPI, the difference was deemed to be a benefit. In Figure 4.5 below, it is illustrated how the PPI differ from the true movement in a market (based on the market variables that influence the commodity of electrical motors in Sasol).
43
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0% Jul 03 / Jun 04 Jul 04 / Jun 05 Jul 05 / Jun 06 Jul 06 / Jun 07 Commodity Jul 07 / Jun 08 Jul 08 / Jun 09
PPI: Domestic output - All groups
Figure 4.5: PPI movement vs. relevant commodity index for electrical motors in Sasol Source: Sasol, 2010c. As illustrated in Figure 4.5, it is clear that where a strategic sourcing team had negotiated the price increase for the period July 08/June 09 to be ten per cent, and the team was measured against PPI, the team would have been penalised as the PPI would only allow for an increase of nine per cent. In actual fact, however, the true index for electrical motors reflects an increase in the market of more than 12 per cent and in terms of the Sasol model, the team’s negotiated ten per cent increase compared to the 12 per cent market increase, assured a two per cent benefit for the organisation. One may very well at this point ask how is an independent index calculated then?
44 By applying the methodology used in Sasol, as explained by Du Toit (2010a), the following model can be developed to illustrate the process: ? ? ? ? Analyse the TCO Model; Determine the relevant cost elements for each of the buckets; Determine the appropriate indices which are weighted according to importance; and Calculate the independent index.
The process of developing an independent commodity index can best be described by the following four steps followed by Sasol:
Step 1 Analyse TCO Model Step 2 Determine cost element per bucket Deliverable Cost elements per bucket Origin of cost element Step 3 Determine relevant published index per cost element Deliverable Published index per cost element Step 4 Calculate Independent Index Deliverable Weighted commodity index for commodity
Deliverable Cost Buckets
Figure 4.6: Developing an independent commodity index By applying the four-step model as developed in terms of Sasol’s experience, the independent market index as developed for electrical motors is used below as an example.
45
Step 1 TCO model for electrical motors Step 2 Cost elements per bucket Step 3 Independent index per cost element
Purchase R107 767
35% Imported Material 15% Local Material 40% Labour
+
5% Transport 5% Overheads
R/$ x US Industrial PPI – All commodities Seifsa table G: Electrical engineering Materials Seifsa Table C3: index of actual labour cost All hourly-paid employees Wholesale prices of diesel: 0.05% Sulphur Gauteng PPI: Domestic output – All groups
Total TCO R188 067
Internal labour R 78 300
100% Labour Table C3: SEIFSA index of actual labour cost: All hourly-paid employees
+
Internal transport R2000 100% Transport Wholesale prices of Diesel: 0.05% Sulphur-Gauteng
Step 4 Calculate the new independent Index formula TCO Elements 57.3% Purchase 41.6% Internal Labour 1.1% Internal Transport 100% Index = 57.3% (35% Imp Material + 15% Local Material + 40% Labour + 5% Overheads) + 41.6% (100% Labour) + 1.1% (100% Transport) Index = 20.1% Imp Material + 8.6% Local Material + 22.9% Labour + 2.9% Transport + 2.9% Overheads + 41.6% Labour + 1.1% Transport Index = 20.1% x [R/$ x US PPI] + 8.6% x Table G + 64.6% x Table C3 + 3.9% x Diesel price + 2.9% x PPI: all groups
Figure 4.7: Development of an independent commodity index for electrical motors in Sasol Source: Adapted from Sasol, 2010c.
46 The independent commodity index does nonetheless have certain shortcomings when used in practice. According to Du Toit (2010a) she has experienced three common issues, namely: i) ii) iii) i) Time lag effect of an index; Finding the right index for a specific cost item; Changes in the structure of the index. Time lags
This is typical in the case of labour increases where labour negotiations take place around July, but the SEIFSA labour index only reflects the new labour rates around October/November. The same applies to the Road Transport index, which also usually lags with two to three months. This means that a TCO will reflect the new cost structure, but because the market index only reflects its adjustment later, the benefits reported will be understated when a market increase had occurred for example. ii) Finding the right index
It is a challenge, and sometimes impossible, to find the right and specific index, that reflects the true market movements 100 per cent correctly. The result thereof, is that you will inevitably end up with either a small over- or under statement of your results in specific cases. iii) Changes in the structure of the index
From time to time, the basket for the calculation of the index changes and this is not always known upfront and will also lead to incorrect measurement. As already mentioned, there is a strict governance process around the development of a commodity index and this can not be adjusted by a strategic sourcing team as preferred and beneficial to the team. In cases where there is a structural change within the commodity, the Centre of Excellence will, through the application of the four steps described, establish a new independent index (Du Toit, 2010a). 4.3.2 Activity adjustment
In order to manage and make value-adding decisions, the commodity TCO model must be measured in relation to the product output of the business (Sasol; 2004: 116). Excluding this productivity ratio from the TCO calculation, distorts the quantification of benefits. The activity level must be the most relevant and highest correlation to a commodity or service. It must constantly take into account and incorporate all production and environmental changes that are experienced in the business. It is, however, quite difficult to establish the appropriate activity measure, as the usage of all commodities is not necessarily directly correlated with the output of a plant, or the number of people working in an organisation (Swanepoel, 2010). In these cases it may be better not to make provision for changes in activity and measure only on a nominal year-on-year basis. One may then
47 encounter abnormal activity compared to the baseline year, but it may be better than to have to consider a once-off baseline adjustment. A practical example of such an instance could be abnormal maintenance that takes place every five years or where major equipment replacements take place. In such instances the intent is to ring fence these abnormal expenditures and remove it from the baseline (Swanepoel, 2010). 4.4 APPLICATION OF THE TCO MODEL AS A MEASUREMENT TOOL FOR THE VALUE CREATED BY STRATEGIC SOURCING: CRUDE OIL The application of the TCO model, as a way by which the value released through strategic sourcing can be measured, is best illustrated through the actual application of the principles described in the first part of this chapter, to crude oil as a commodity in Sasol. Crude oil is the single largest valued commodity procured by Sasol and sourcing of crude oil on the principles of strategic sourcing is governed by a Crude Oil Steering Committee. One of the agenda points of the Steering Committee is the actual performance of strategic sourcing as measured in terms of the TCO Model. For purposes of illustrating the TCO model, this research study looks at the comparison between the six-month periods July to December 2008, to July to December 2009, as reported to the Sasol Crude Oil Steering Committee in May 2010. 4.4.1 Elements of the Crude Oil TCO model
The elements of the Sasol Crude Oil TCO model, was derived from the life cycle of the crude oil purchasing process, with the following key elements: Purchasing, Shipping, Storage in Durban, Piping and Storage at Plant (Van Niekerk & Sefoka, 2010: 2). The key elements of the purchasing process, together with the cost drivers per element are illustrated in Figure 4.7 below. These cost elements are then quantified, which adds up to the TCO of crude oil. In the case of crude oil, due to sufficient buffer capacity at the Sasol refinery called Natref, there is no provision for opportunity cost in the TCO model.
48
Purchase of Crude Oil
Shipping of Crude Oil to South Africa
Storage in Durban
Pipeline cost to refinery
Refinery cost
Cost Elements
•Purchase Price •Letter of credit cost
•Insurance •Freight Cost •Surveying cost •Clearing and … •Cargo dues •Shipping agents commission •Demarcage
•Cargo Due •NATCOS
•Pipeline cost
•Storage •Refining
Figure 4.8: Purchasing life cycle cost elements for crude oil Source: Van Niekerk and Sefoka, 2010: 7. From the cost elements described in Figure 4.8 above, the TCO model below (Figure 4.9) in millions of US$ was derived.
1000 900 827.41 800 700 600 500 400 300 200 100 0 NATCOS Capital Costs on Inv Clearing Costs Piping Costs Insurance Cargo Dues Demurrage Other Total Purchase TCO FY 09 Freight 20.13 17.94 0.39 0 3.09 0.48 2.03 2.41 3.28 877.16
Figure 4.9: TCO of crude oil in Sasol July to December 2008 Source: Van Niekerk and Sefoka, 2010: 7.
49 The different cost elements of the TCO for crude oil are described in Table 4.1 Table 4.1: Cost elements of Crude Oil TCO model
Cost element Total purchase Freight Insurance Clearing costs Demurrage Cargo dues NATCOS Capital costs in Inv. Piping costs Other Related costs Description The sum of all purchases for the 6 months The cost of ocean freight from the port of loading to Port of Durban The cost of insurance on the cargo Costs incurred in clearing the cargo through customs Costs associated with standing time and delays of ships Cost paid to the ports authority for cargo movement within the port The cost (fixed and variable) of handling crude at NATCOS The cost of carrying crude inventory The cost of piping the crude from Durban to Natref, Sasolburg. Smaller costs aggregated to ease of reference e.g. was risk, tug charges, surveying and piracy deviation The cost of taking future position and other smaller finance costs, guarantee fees, interest, etc.
Source: Van Niekerk and Sefoka, 2010: 8. 4.4.2 Activity adjustment
For the purpose of activity adjustment, the actual Natref production output is used. For the period under investigation, this revealed that the production had increased by 3.3 per cent (Van Niekerk & Sefoka, 2010: 6). This means the TCO of the first six-month period will be adjusted upward by 3.3 per cent. In other words, the TCO of US$877.2 million as per Figure 4.9 would increase by 3.3 per cent to US$905.7 million. 4.4.3 Market adjustment
For the market adjustment, Sasol uses the Brent Oil prices (Van Niekerk & Sefoka, 2010: 8). The index was constructed using the Brent Oil prices with July 2007 as a base, as published on the Sasol Commodity Indices Model. Each subsequent price is divided by the base price and the quotient is the index. The average indices for each six-month period are compared to determine the direction of prices in the two periods. The indication was that crude oil prices fell by 15 per cent between the two periods as is illustrated in Table 4.2.
50 Table 4.2: Percentage change in crude oil price with July 2007 as base
Period July 2008 August 2008 September 2008 October 2008 November 2008 December 2008 January 2009 February 2009 March 2009 April 2009 May 2009 June 2009 July 2009 August 2009 September 2009 October 2009 November 2009 December 2009 July 2009 to December 2009 vs. July 2008 to December 2008 Brent Oil $/Barrel 39.5% 29.0% 20.3% 9.0% -1.8% -11.2% -17.3% -22.0% -25.2% -27.5% -28.6% -28.6% -5.2% 0.6% 0.0% 1.7% 3.8% 4.7% -15.9%
Source: Sasol, 2010c. To test whether the Index was relevant to the spot and term purchases, a regression was performed on actual prices (spot and term) against the Brent Oil prices. The results produced a very good correlation between the Brent crude oil prices and each series of spot and term purchases respectively. The worst correlation produced an r² of 0.95, meaning only five per cent of the spot price variation cannot be explained by the Brent Oil price variation. (See Table 4.3 for results). To establish whether the correlation could have produced significantly different results, the P-value was established. The worst figure in bother correlations was 4.7 x 10-15 (spot prices regression), meaning the chance that the regression results are completely incorrect is 4.7 x 10-13 %. Consequently, it can be accepted that it is very unlikely that the results are incorrect and hence the index can be considered to be a fair description of the behaviour of the spot and term prices.
51 Table 4.3: Statistical results of regression analysis Brent Oil and Spot Purchase
SUMMARY OUTPUT Regression Statistics Multiple R 0.97418647 R Square 0.94903928 Adjusted R Square 0.94661258 Standard Error 6.60622884 Observations 23 ANOVA Regression Residual Total df 1 21 22 SS 17067.707 916.48745 17984.194 MS 17067.70692 43.64225955 F 391.0821093 Significance F 4.69877E-15
Intercept Brent $/Bbl
CoefficientsStandard Erro 2.56533708 4.2329105 0.95904324 0.0484958
t Stat 0.606045664 19.77579605
P-value 0.550979698 4.69877E-15
Lower 95% Upper 95% Lower 95.0% Upper 95.0% -6.237482248 11.36815641 -6.237482248 11.36815641 0.858190683 1.059895796 0.858190683 1.059895796
The purchase cost portion of the TCO for the first six-month period was then adjusted downwards by 15 per cent as indicated by the index. This means that the production adjusted purchase cost of US$905.7 million was reduced by 15 per cent (US$128.5 million) resulting in an adjusted TCO of US$777.3 million. The final result was a TCO adjusted for both production and price variation. 4.4.4 TCO Comparison
The last step in the process is now to compare the TCO for July to December 2008, with the TCO for July to December 2009, after making provision for the volume and market adjustments as explained in paragraphs 4.4.2 and 4.4.3. The US$28.95 million benefit was the result of a range of strategic sourcing initiatives which focused on the various TCO elements. Some of the main elements include amongst others, demurrage and freight bill.
52
1200
1000
877.18 28.58
128.45
777.31
800
28.95 748.36
600
400
200
0 TCO July - Dec 2008 Volume adjustment Market adjustment Adjusted baseline Benefit TCO July - Dec 2009
Figure 4.10: TCO comparison for crude oil in Sasol July to December 2008 vs. July to December 2009 Source: Van Niekerk and Sefoka, 2010: 8. 4.5 PROBLEMS IDENTIFIED WITH TCO MEASUREMENT
Within Sasol, various problems with this approach to measurement have been experienced over time and had to be addressed. 4.5.1 Linking of benefits to financial statements
One of the first problems that you encounter from a measurement perspective, according to Swanepoel (2010), is difficulty in linking these buckets to the financial statements due to the fact that the organisation does not budget on a TCO basis but on a direct cost basis, and then also, only per financial cost element. For example, if you consider the TCO of a bearing for a specific financial year, the direct cost will be the number of bearings purchased multiplied by the price per bearing which can be linked directly to the costs incurred on the income statement and in the financial budget. The indirect cost associated with a bearing, which consists of inventory carrying cost, however, cannot be linked directly to the numbers on the financial statement or the budget because these are not budget elements.
53 Internal cost refers to the cost of installing a bearing and relates to various budget elements such as labour, maintenance cost and/or operations cost but opportunity cost which relates to the cost of downtime should the bearing fail, is again very difficult to link back to the financial statements due to the same reason stated above. The impact of the lost production would indirectly impact the turnover, but not only is this extremely difficult to quantify, proving the direct relationship between a bearing failure and loss in sales seems an almost impossible task as various factors need to be considered such as, for instance, availability of buffer stock or the specific reasons for the bearing failure (Swanepoel, 2010). 4.5.2 Availability of data
Van Wyk (2010) stated that one of the biggest problems in measuring TCO is the availability of data. In Sasol, there are more than 13 enterprise resource planning (ERP) instances which function with little or no interface and result in the task of drawing data to populate a TCO model on a monthly basis, being a very time-consuming task. In addition thereto data for many of the cost elements of a TCO model, is not available in the formal ERP system. One therefore has to rely on manually-compiled reports from informal data sources which pose major accuracy and integrity risks. 4.5.3 Establishing a market index and activity adjustment
The problems experienced with regards to the above are as per the detail discussion in paragraphs 4.3.1 and 4.3.2 of this research report. 4.5.4 Time and resource constraints
According to Swanepoel (2010) the time and resources required to track value released at detail level as explained in this chapter, are not warranted for all commodities, as in some instances this may lead to more focus on the trading than on the actual process of strategic sourcing and the continuous search for new optimisation opportunities. It is due to these problems that a firm decision was taken in Sasol, to create a set of ground rules for tracking and measurement of the impact of strategic sourcing, and in order to create a more practical approach to the measurement of the value-add of strategic sourcing while still remaining within the framework of the TCO approach (Bornman, 2010a). This is analysed in great detail in Chapter 5.
54 4.6 ? ? ? ? ? ? ? ? 4.7 KEY LEARNINGS TCO encompasses all cost elements of a commodity. To effectively measure TCO improvement on a year-on-year basis, the baseline needs to be adjusted for market changes and activity changes. For TCO market adjustment an independent index needs to be established. This index is a function of the true cost elements of the TCO. The index has certain shortcomings which need to be considered. Activity adjustment is difficult, as an appropriate activity level is difficult to find. Measurement of TCO is a difficult and time-consuming process. Data availability is a major stumbling block. CONCLUSION
The TCO model approach to the measurement of value released from the strategic sourcing process is an excellent solution to the problem of proving once-off value-add through application of strategic sourcing principles. In Sasol, this approach has been well entrenched over the years after Sasol was persuaded in the early 2000s to implement strategic sourcing and the Sasol Board required continuous feedback on the progress made in the Sasol Group. Not only does this approach provide an indication of the value-add through various strategic sourcing activities, but it also serves as an excellent gate keeper over time to ensure sustainability of achieved results by ensuring that no leakages occur, and provides for immediate corrective action in cases where leakage does occur. Simultaneously, the independent market index serves as a barometer for movements and activity in the market which offers the ability to monitor the financial impact thereof on a continuous basis. Unfortunately the continuous tracking and monitoring of a commodity at this very detailed level is time-consuming, complex and poses many challenges and risks. To counter the various challenges and address the issues, Sasol had to adapt its approach to measurement by providing for a more practical measurement methodology which is discussed in the next chapter in more detail.
55
CHAPTER 5 MEASUREMENT OF STRATEGIC SOURCING VALUE CREATION: SASOL BENEFITS MODEL
5.1 INTRODUCTION
Victory is sweetest, when you’ve known defeat ~Malcolm Forbes. Due to the problems experienced with full TCO measurement as discussed in Chapter 4, Sasol had to re-design its measurement model in 2003, which lead to the establishment of what is known today as the benefits model and which is currently used in Sasol. At that point the organisation experienced that more time was spent on collection of data and measurement of benefits, than focusing on actual true value-adding activities to create value, and implementation of cost optimisation ideas (Van Wyk, 2010). The new approach to measurement was still based on the original principles of TCO measurement as described in Chapter 4. The model is based on five requirements for benefits calculation. The benefits are then categorised into different batches in accordance with the number of requirements that can be complied with (Swanepoel, 2010). The requirements lay the foundation for measurement, and value, referred to as benefits, can be reported in various segments depending on the level of complexity involved in implementation of the optimisation ideas. This allowed strategic sourcing teams to focus more on the actual value-adding processes and activities. This chapter focuses on the Sasol Benefits Model and the principles it is built on, as well as the requirements set for measurement and the governance around the reporting of the value released through the strategic sourcing process. 5.2 BENEFIT CATEGORIES
The categories of benefits provide the structure that effectively assesses the identification, calculation and tracking of benefits that originate from the Sasol strategic sourcing process (Sasol, 2010a: 8). The benefits categories firstly differentiate between sustainable and once-off benefits. Sustainable benefits are further categorised into three types into which a benefit will be classified based on the level of compliance with the set requirements for each category (Swanepoel, 2010).
56
Benefits
Sustainable
Once-off
TCO
Idea tracking
Price containment
Figure 5.1: Classification of benefits in Sasol Source: Sasol, 2010a: 9. Figure 5.1 illustrates the benefits classification as it is used in Sasol today. The study now focuses on analysing the model by first distinguishing between the principles of sustainable and once-off value release and thereafter a detailed analysis is done of the five measurement requirements for sustainable benefits, as developed by Sasol. Lastly, the categorisation of sustainable benefits into its three sub-categories: TCO, idea trading and price containment is discussed. The study also tries to highlight that the TCO principles are still complied with. 5.2.1 Sustainable versus once-off benefits
Sustainable benefits refer to the value released as a result of optimisation ideas implemented in a specific financial year and which yield continuous benefits year-on-year. Sustainability is generally achieved when a permanent change in a process is made and successfully implemented. To ensure sustainability it is important that the new way of doing is accepted, embedded and becomes a standard working procedure in the organisation. According to Sasol (2010a: 9) it is easier to achieve sustainability in an environment which is structured for repetitive activity, but it requires a huge effort from the strategic sourcing teams to ensure that these benefits are sustained over time (Van Wyk, 2010). The principle of a sustainable benefit is illustrated in Figure 5.2 below, where the red line indicates the unit cost of a commodity in the manufacturing process and the green line indicates the new unit cost after a sustainable idea, i.e. a change in specification, was implemented.
57
Cost
Current Effect of sustainable idea New
Time
Figure 5.2: Sustainable benefits illustration Once-off benefits are benefits achieved in a particular financial year, but are not sustainable beyond the period in which they were achieved, for instance a once-off discount negotiated with a supplier. At the end on the benefit period, the cost will revert back to the original level (Sasol 2004: 113). The principle of a once-off benefit is illustrated in Figure 5.3 where the red line again indicates the current unit cost of a commodity in the manufacturing process and the green line indicates the change in the cost structure.
Cost Once-off benefit
Current
Time
Figure 5.3: Once-off benefits illustration
58 5.2.2 Five requirements of benefits calculations
Figure 5.1 illustrates how benefits can be classified in various categories. The difference between these categories relates to the five requirements developed by Sasol for benefit calculation. The requirements as illustrated in Figure 5.4, are used in various combinations to result in a benefit being classified into one of the categories and are now discussed in greater detail.
MECE
TCO Model
Requirements
Baseline
Index Activity level
Figure 5.4: Five requirements for benefits calculation Source: Adapted from Sasol, 2004: 115. 5.2.2.1 Mutually exclusive, comprehensively exhaustive (MECE) The requirement of mutually exclusive, comprehensively exhaustive (MECE) is based on the principle of interdependence that exists between various commodities in the production process. As a result of this interdependence, certain benefits realised due to a strategic sourcing initiative, may impact negatively in another area, and therefore the principle of MECE was put in place (Swanepoel, 2010). Mutually exclusive in strategic sourcing refers to the boundaries of a particular commodity that must be properly defined in its relation to other commodities in order to ensure that double counting of benefits do not take place. Comprehensively exhaustive means that all cost drivers influencing a commodity are identified and taken into account. Factors influencing a commodity that are not identified may lead to inaccurate measurement (Sasol, 2010a: 11).
59 5.2.2.2 TCO model The principles of the TCO model were described in detail in Chapter 4, paragraph 4.3. As is explained later, the new approach to benefits calculation did not replace the TCO measurement, but it merely developed various categories of benefits depending on adherence to specific combinations of the set requirements. Therefore the TCO model is still relevant as a requirement. According to Sasol (2010a: 11), the TCO model identifies all elements that drive and influence the TCO of a commodity, and these elements are then classified in four cost buckets. Refer to Figure 4.1 in paragraph 4.2 for detail on TCO cost buckets.) 5.2.2.3 Activity level In order to be able to manage commodities and make value-adding decisions, a commodity’s performance must be measured in relation to a productivity indicator, i.e. plant production. Excluding this productivity ratio from benefits calculation may distort the quantification of the benefits achieved. The activity level must be relevant and highly correlated to the usage of the commodity (Sasol, 2010a: 11). 5.2.2.4 Indices A commodity index is the sum of all the variable elements that influence the price of a commodity. The prices of commodities in global markets fluctuate due to many factors, such as: ? ? ? Supply and demand forces; Currency rate of exchange; Inflation.
5.2.2.5 Baseline The positive or negative impact of benefits realised, can not be assessed unless it can be compared to a previous figure. A baseline spend or base price enables comparative analysis and decision making by providing a reference for comparison. A baseline spend/base price is a defined comparable base from the previous reporting period (Sasol, 2010a: 12).
60 5.3 BENEFITS MODEL
Through mapping of the five requirements for benefit calculations, in relation to the benefit categories as explained in Figure 5.1, the benefit model used in Sasol was developed. The Sasol Benefits Model is illustrated in Figure 5.5 and clearly shows how satisfying a specific combination varying from only one requirement to all five requirements per instance, classifies benefits achieved into one of the benefits categories.
Benefits
Sustainable
Once offs
TCOR Index Requirements Baseline Activity level TCO tree MECE
Ideas
Price
Cost
Capital
y y y y y
y y ü y X X
y y X X X
y y X X X
y X X X X
Figure 5.5: The Sasol Benefits Model Source: Sasol 2010a: 12. Now, the five requirements for the three categories described under sustainable benefits are compared to see to what extent this model as discribed in Figure 5.5 was able to address the issues raised in Chapter 4, paragraph 4.5 with regards to the measurement of the strategic sourcing value release by way of the TCO model. 5.3.1 TCO reduction
As already mentioned, the model does not replace the TCO measurement process, it merely develops and expands on it. Therefore it is still TCO reduction. What is interesting to note, however, is that this is the only category which requires compliance to all five requirements and according to Bornman (2010a), this category indicates the highest level of measurement in the group. Sasol sets targets on an annual basis for each strategic sourcing team aimed at increasing the number of commodities measured at this level.
61 5.3.2 Idea tracking
The second category of measurement is called idea tracking and this category requires compliance to three of the five requirements for benefit calculation. The principle applicable when ideas are tracked at this level is closely linked to the main intention of strategic sourcing which is to continuously search for ideas, in conjunction with end users and suppliers, to reduce the cost structure of a commodity. By tracking benefits at idea level, no detailed TCO model exists and therefore benefits can not be proven to be mutually exclusive and comprehensively exhaustive (MECE). In this case, a baseline is established for the area on which the idea is focused and the only cost elements usually adjusted in such cases are the relevant independent index and activity level (Bornman, 2010a). This ensures that in cases where it is very difficult to collect data for the TCO model, the strategic sourcing team is enabled to focus on a specific area and track the progress for only that idea. 5.3.3 Price containment
This is the most general type of benefit reported in Sasol according to Bornman (2010a) and the benefits occur mainly through negotiations with suppliers. In order to calculate the benefit one needs an independent commodity index as well as a baseline price. The positive difference between the percentage price increase/decrease negotiated by a strategic sourcing team, and the percentage increase/decrease calculated by the independent index, represents the benefit that can be claimed for this category. Due to the fact, however, that there is no activity level adjustment, one may end up with the problematic scenario where benefits are only achievable by means of procuring in larger quantities (Sasol, 2004: 118), and strategic sourcing teams are therefore encouraged to move away from focusing on price containment and rather move towards idea tracking and TCO measurement. 5.3.4 Once-off
To claim a once-off benefit, requires at least a baseline cost and index to measure against. This is typical in cases where benefits are achieved through once-off sales on specific commodities, due to oversupply. It is, however, well known in the market that oversupply does not last, hence its classification as a once-off benefit (Bornman, 2010a). For this category, the baseline is represented by the current price, and the relevant index indicates the market movement in the price of the commodity.
62 5.4 SASOL BENEFITS GOVERNANCE PROCESSES
Swanepoel (2010) confirmed that the process of setting benefit targets as well as the reporting of benefits are governed by strict internal processes and that the actual value reported is audited on an annual basis. The governance processes around benefits can be divided into three specific areas of focus namely: i) ii) iii) Annual target setting by the strategic sourcing teams; Obtaining sign-off on ideas implemented; and Lastly, the formal auditing of the value reported each financial year.
It is important to note that strategic sourcing teams are rewarded by means of annual bonuses for achieving the targets for each financial year. The Sasol governance processes are formally documented in the Procedure for Sourcing Strategy Formulation (Sasol, 2010b) and the Procedure for Benefit and Spend Calculations (Sasol, 2010a). 5.4.1 Target setting
Once a year, formal targets are set per strategic sourcing team and which account for 80 per cent of each teams’ performance contract (Bornman, 2010a). These targets are set in accordance with the benefits model and the team must identify opportunities for the commodities in their respective portfolios, and indicate the benefit categories in which these benefits will most likely be realised. The targets are then presented to the main end users, who must also formally sign off on these targets. After the targets have been approved, they are presented to the financial managers of the various business units in Sasol, who each need to ensure that the expected value released by the strategic sourcing teams are captured in the respective business units’ budgets. Thereafter each team’s progress is monitored on a monthly basis, by means of monthly reporting of benefits achieved against the set targets. 5.4.2 Reporting of benefits
According to Du Preez (2010), it was absolutely vital to track the benefits achieved due to the required reports to the Group executive committee on a monthly basis when they started to implement strategic sourcing in Sasol. Within the first couple of months, a team was set up to develop a tracking tool because there was nothing available in the market that could fulfil this requirement. This lead to the development of an in-house system called NGIS, which is still used today. The NGIS system was developed as a benefits tracking and monitoring system (Sasol, 2010a: 13) and serves as a central storage database, where all potential and actual benefits are registered.
63 The NGIS system is also used during the year-end wrap up process, to confirm anticipated and reported benefits. The structure of the NGIS system is aligned to the benefits model and all benefits are captured in the same manner. All benefits reported on the NGIS system must be supported by a sign-on document, supporting the benefit reported. 5.4.3 Benefits sign-on process
Before any benefit targets can be set, end users, also the budget owners, are required to sign a document which signifies their agreement with the target set for the financial year. This is referred to as sign-on by the end user (budget owner). This process was established to obtain alignment between the strategic sourcing team and the budget owner as a means by which to break down the silo method of operation in the organisation. The value released via strategic sourcing can not take place in isolation and therefore a formalised and cooperative process had to be established. Figure 5.6 is an example of the sign-on document used in Sasol. After the benefit has been realised, the budget owner will again sign-off on the value released and only thereafter can it be reported on the NGIS system (Bornman, 2010a).
64
A. Benefit Details Team Name Commodity Name: Financial Year B. Benefit Description Sustainable Benefit information Price Containment Idea realised TCOR Once-Off Once off Cost/Income Once off Capital
Benefit Type NGIS Title NGIS Idea number Benefit description Notes: A short description of how the benefit will be realised and the estimated total value. The BU (if it is a GSST) that the benefit will accrue to. The period over which the benefit will be reported All supporting documents (e.g excel sheet etc) must be kept with the sign-on document C. Sign-on Strategic Sourcing Manager / P&SM Manager / Procurement Manager / Supply Chain Manager Name: Signature: Date: That: The benefit calculation and reporting methodology used are in compliance with the benefit ground rules. The initiative has been implemented and that the benefit is being realised. Sasol Stakeholder Name: Signature: Date: That: The initiative has been implemented and that the benefit is being realised. The TCO methodology is understood and the activity levels used (in the case of TCOR) in the calculation are correct. Index Centre of Excellence Name: Signature: Date: That: The Indices used in the benefit calculation are representative of the commodity/service
Figure 5.6: Benefit sign-on document Source: Sasol 2010a: Annexure A.
65 5.4.4 Auditing of benefits
As stated before the reported benefits are audited on an annual basis and this requirement also forms part of the Sasol formal auditing schedule. The audit process consists of the following actions (Sasol, 2010a: 14-15): i) The team presents a list of realised benefits as registered in NGIS that has been reported for the financial year; ii) Initially, 80 per cent of the value of reported benefits is selected for the audit process. Reported benefits are also selected based on the uniqueness and value of the underlying principle of the initiative; iii) iv) A random selection from the remaining 20 per cent also forms part of the audit scope; For the selected benefits, sign-on documents are assessed and should reported benefits not be supported by completed sign-on documentation, they are rejected from the reported figures regardless of the fact that they have been implemented; v) Where proof of sign-on is provided, the benefits are analysed by auditors to understand the principles which govern the implemented initiative; vi) All fundamental assumptions that have been made and the validity thereof have to be proven and are assessed; vii) ? ? ? ? ? ? The following aspects are assessed: Whether the benefit is sustainable, once-off or both; The method used for calculating the reported saving; Whether the ground rules were correctly applied; Whether the correct benefit classification had been used; Whether the input costs to do the calculations is supported by valid documentation to confirm its origin; Whether the input costs make business sense and the origin thereof is verified where necessary; viii) Next, the auditor ensures that reported benefits, which flows over different financial years, are not duplicated and that benefits are only reported for a 12-month period; ix) Economic indices are evaluated to be representative of the specific commodity or service it represents; and x) Application of the index is evaluated in terms of the ground rules.
66 5.5 ? ? ? ? ? ? ? 5.6 KEY LEARNINGS There is a distintion between once-off and sustainable benefits. The TCO principles are still relevant. The five requirements as developed by Sasol is used to the benefits reported. Target setting is a key element to the strategic sourcing process. End user acceptance of the value added is important. The value-add needs to be taken out of the budget. Auditing of the value-add is important to the integrity of the process. CONCLUSION
In its initial implementation of strategic sourcing and specifically as a result of the complexities and problems experienced with the TCO model of measurement of achieved benefits, Sasol had to adapt its measurement approach to allow for a more practical and user-friendly model so as to not over-complicate its measurement methodology. The measurement of achieved benefits is a very important aspect of the strategic sourcing process as it provides valuable information to senior management on the actual progress made in terms of the value-add of strategic sourcing. Experience, however, proved that an over-complicated system misdirects the focus of strategic sourcing as teams spend unnecessary time on tracking and reporting of benefits, and less time on the actual realisation of optimisation ideas. The accuracy and integrity of benefit reporting is the last crucial link, and to ensure this, stringent governance processes were developed which are still in place today. Adherence to these processes is audited on an annual basis as part of the formal audit process in Sasol and to ensure accurate and reliable benefit reports. Another important aspect to consider is that a function need to perform at all levels in an organisation to be seen as a value-adding partner. Chapter 6 will focus on what needs to be in place for a procurement function to be seen as a truly value-adding function which is more than just the value released by the strategic sourcing process.
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CHAPTER 6 SUSTAINING A WORLD-CLASS FUNCTION
6.1 INTRODUCTION
We were born to succeed, not to fail ~Henry David Thoreau. Sasol extracted more than R3.8 billion in value from the procurement of goods and services in the organisation, through its strategic sourcing process over the past ten years. But, a function like procurement can not only focus on strategic sourcing in order to be seen as a value-adding function. Within Sasol, the procurement function came to realise that, despite the well-functioning strategic sourcing process, and the sustainable results delivered as a result thereof, the function as a whole needed to perform at all levels. There is a principle of procurement referred to as a “non-negotiable” which is to procure the right product, at the right time, at the right price and at the right place, which still holds true today (Brockwell, 2007: 1). When the procurement function is unable to satisfy the needs of the end user, perceptions become negative towards the function and all the value released to date as a result of its world-class processes also starts to lose its appeal. One may even notice a slow descend into losing the prized seat at the boardroom table and the organisation starts to see procurement as just another function again, with merely a transactional mandate as was the case historically. Against this background, the Sasol procurement function realised that it had to review its value proposition in the wider sense than just its strategic sourcing process and in the process a hierarchy of agendas (HOA) was established which caters for all the important elements in procurement and not only strategic sourcing (Kritzinger, 2010). 6.2 KEY REQUIREMENTS FOR AN EFFECTIVE PROCUREMENT FUNCTION
In order to manage a procurement function as a strategic, value-adding partner in the organisation, it is extremely important to ensure that the function’s vision, purpose and value proposition is aligned with that of the broader organisation’s vision and purpose. To achieve this, the respective business unit procurement functions in Sasol, jointly developed a vision and purpose statement that was aligned throughout the Sasol group of companies (Kritzinger, 2010). 6.2.1 Vision
Kotelnikov (2010: 1) defines a vision as an inspiring statement of what the organisation intends to become and to achieve at some point in future. A vision refers to the intentions that are broad, allinclusive and forward thinking. This same principle is true for a function that wants to stay relevant well into the future.
68 The vision for the procurement function in Sasol also reflects this principle of continuously striving to be the best. The vision of the Sasol’s procurement function, according to Kok and Sefoka (2008: 6) is: “To be a world-class procurement business partner.” According to Kok and Sefoka (2008: 6), the vision expresses two very important future desires of the procurement fraternity. The first is to be a “business partner”, in recognition of the fact that the procurement function must enable the business to reach its objectives. The second is to be “worldclass”, thereby communicating a commitment to employ procurement practices that meet or exceed their internal customers’ expectations. 6.2.2 Purpose
According to Williams (2008: 1), understanding the purpose of a function affects the function’s performance. A purpose brings deeper meaning to the function and the function is not only delivering a service, but actually understands how its actions contribute towards the organisation’s overall purpose. The purpose of the procurement function in Sasol according to Kok and Sefoka (2008: 6) has been defined as: “Apply and ensure functional procurement excellence in order to (i) shape, (ii) continuously improve and (iii) safeguard Sasol’s competitive advantage.” The purpose also identifies three key activities that enable the function to contribute to the business’ competitive advantage. The description and intent related to each of the three activities are described in Table 6.1 below, and were derived from the work of Kok and Sefoka (2008: 7-10). Table 6.1: Sasol procurement function purpose
Main activities Shape Description Activities that the procurement function engages in together with the business, to add value to the business and its strategies Activities that it must improve at in order to support the maintenance of the Group’s competitive advantage Actions Business strategy Sourcing strategies to support business Competent people Efficient processes and systems Benchmark the procurement function Produce market intelligence Create new benefits through the strategic sourcing process Stable supply of goods and services at the required price Apply risk management strategies. Build reliable supply networks
Continuously improve
Safeguard
Addresses issues of business risk as far as the supply markets to the Sasol Group and application of relevant governance to internal processes are concerned
69 i) The shaping activity refers to the establishment of sourcing strategies that support the business strategy together with efficient processes and systems. ii) The principle of continuous improvement, which is also one of the core values of Sasol, refers to the process of continually seeking ways in which to do things better and more effectively. This is achieved in Sasol through continuous benchmarking of the procurement processes and the function as a whole. iii) Safeguarding focuses on the protection of the company against risk. As the custodian of a spend base of more than R57 billion, the procurement function has an important role to play in ensuring ethical and honest business practices in the management of an expenditure of this magnitude on an annual basis. 6.2.3 Value proposition
The principle of a value proposition is sometimes confused with marketing and market offerings to customers. But if the intention is to be a world-class function, and more to the point, a world-class procurement function or world-class marketing function or a world-class human resources function, a solid value proposition must be developed for customers, and this, in the examples above means internal customers. Lake (2010: 1) says that a value proposition needs to be clear and concise and it equips you with the following benefits to your customers, namely: improves your operational efficiency and it will help you to increase not only the quantity, but also the quality of your offering to your customers. Kok and Sefoka (2008: 8) define the Sasol procurement value proposition as follows: “The strategic formulation and implementation of procurement functional strategy through competent people, effective processes and systems and stakeholders, in line with global best practices and supply-chain strategic framework.” The value proposition communicates the benefits that Sasol would derive from an effective and efficient procurement function. The Sasol procurement value proposition refers to two groups of people, namely: internal competent people and the stakeholders of the procurement fraternity. According to Kritzinger (2010), the skills base of the people within procurement is a critical success factor through which the function needs to deliver on its value proposition. This implies the appointment of the right people, who are able to deliver value on a strategic level, and who are able to move to a strategic level, away from the traditional administrative and transactional roles. The stakeholders are those people/functions who are the beneficiaries of the value extracted and offered by procurement, and Kok and Sefoka (2008: 9) have identified three key products that procurement offers to its stakeholders and which are described in Table 6.2.
70 Table 6.2: Value release to key stakeholders by procurement
Product Benefits Sourcing strategies Description This is the value release via the strategic sourcing process as described in Chapter 5. Before one can enter the supply market, a proper sourcing strategy needs to be in place. Procurement functions are trained in the preparation of these strategies. Procurement contributes significantly to the business bottom line and in the process collects massive amounts of data, which is turned into valuable information.
Visibility of information
6.3
THE HIERARCHY OF AGENDAS FOR THE SASOL PROCUREMENT FUNCTION
The key strategic sourcing focus areas for the procurement function in Sasol was derived via detailed workshops with key stakeholders in the organisation, in order to do a proper assessment of the needs of stakeholders (Kritzinger, 2010). But, as already mentioned, it is also important to ensure that the key building blocks of the function are in place in order to ensure that the strategic value-add can be delivered. This lead to the procurement function defining a hierarchy of agendas (HOA) to prioritise the initiatives it will embark on. For each agenda, a definition of victory (DOV) was developed against which the function can track its performance (Kok & Sefoka, 2008: 10). The HOAs and DOVs are supported by the vision, purpose and value proposition as discussed in paragraph 6.2 above. As illustrated in Figure 6.1, the HOA as developed in Sasol is presented as a triangle on top of a square that represents the key building blocks that must be in place to ensure that the procurement function operates in an effective and efficient manner. The triangle represents the strategic focus areas that represent the value-add from the strategic sourcing process. One can argue that even if an organisation decides not to embark on the process of strategic sourcing, the elements in the square still need to be in place to ensure a value-adding function. The following section of the report analyses the HOA for the procurement function in Sasol which is described in Figure 6.1.
71 HIERARCHY OF AGENDAS
STRATEGIC
New benefits
Sustain already achieved benefits
Sourcing of supply
FOUNDATION 1) 2) 3) 4) 5) 6) Stakeholder relationships Standardised processes Governance Contract management ERP system support Skills development
TACTICAL
VISION, PURPOSE, VALUE PROPOSITION
Figure 6.1: Hierarchy of agendas Source: Adapted from Kok and Sefoka, 2008: 10. 6.3.1 Foundation
The foundation of the HOA model refers to the tactical aspects that must be in place for a function to operate in an effective manner. Sasol highlights six building blocks that form the foundation of a procurement function. 6.3.1.1 Stakeholder relations According to Kritzinger (2010) it is of extreme importance for a procurement function to understand the needs of its internal customers correctly in order to be able to satisfy these needs. It remains the procurement function’s role to balance these needs with what is available in the supply market. Thus, for procurement to be successful, the function needs to truly understand what the business pressures and priorities are (Kok & Sefoka, 2008: 11).
72 6.3.1.2 Standardised processes Purchasing Insight (2010: 2) states that a procurement process provides a model and framework within which to work to: ? ? ? Save time, and ensure that you obtain the right solution to meet you business needs; Ensure you pay the right price; Ensure that suppliers are familiar with the steps you take and know that they are dealing with a professional organisation. One of the key objectives in the Sasol Group is the drive towards “One Sasol Way”. It is believed that substantial value can be released through the standardisation of procurement processes, and that this will also support governance. In order to achieve this, Sasol has embarked on a project named Functional Excellence of which one of the main deliverables is to standardise business processes throughout the Sasol group of companies (Kritzinger, 2010). 6.3.1.3 Governance According to Procurementleaders (2010: 1), good governance across procurement can be costly in terms of resources, but it is an important basis for increased business performance, reducing risk and making headway in combating the perennial problem of dissident spending. As per the Sasol Code of Ethics (2004), all procurement processes shall be transparent, honest and equally applicable to all parties. The governance procedures and processes related to procurement must be clear, available and accessible to all in the group. It is hence very important that all policies and procedure are clear and auditable and that it covers the main potential risk areas (Bornman, 2010a). Sasol, as required due to its listing on the New York Stock Exchange, must comply with Sarbanes Oxley requirements which have a strong link to the procurement function. 6.3.1.4 Contract management Procurement applies a number of tools in its interaction with the supply market and contracting is one of them (Kok & Sefoka, 2008: 11). It is through the conclusion of a contract that Sasol commits itself to a supplier with the reciprocal expectation that the supplier will fulfil its responsibilities to Sasol’s satisfaction. While the conclusion of a contract can be a lengthy process, it is the very manner in which the process is executed that determines whether the intended relationship becomes mutually beneficial over the term of the contract. Therefore contract management is regarded as an important business tool in the procurement function’s ability to deliver value (Kok & Sefoka, 2008: 11).
73 6.3.1.5 ERP system support The Systems Applications and Products (SAP) ERP system in Sasol is the platform that enables procurement to execute its transactional responsibilities and allows access to end users into the contracts which were established through the strategic sourcing process (Kritzinger, 2010). 6.3.1.6 Skills development The last building block in the foundation for an effective procurement function, is skills development. To engage on a journey to become a world-class procurement function, new skills are one of the most essential requirements to elevate the function from a transaction-based function into a true strategic function. To achieve this, Sasol had to invest substantially in the development of its people over the last number of years (Du Preez, 2010). Sasol also formed an alliance with the University of South Africa (UNISA) to develop a subject specific programme for strategic sourcing as the company believes in the principle of developing its own people (Kritzinger, 2010). 6.3.2 Securing of supply
The world’s business cycle has resulted in challenging trading environments both locally and internationally. This requires additional vigilance on the part of the procurement function. A breakdown or interruption of critical commodities to Sasol’s operations can result in operational breakdown (e.g. lost production time), increased costs and possibe damage to the Group’s reputation and to manage this risk is, fundamentally, to manage supplier relationships. Detailed and thorough supplier appraisal procedures are advisable for efficient supplier management. In general, one should utilise the contracting process as a means of interacting with suppliers, to identify those suppliers whose approach and ethos are broadly consistent with that of your own organisation. A good and reliable supplier greatly increases the probability of effective communication, which subsequently, minimises the odds of supply and demand problems. When working in partnership relationships with suppliers, it is more likely that suppliers will highlight anticipated and/or potential risks in the supply chain. Effective supplier relationships require a delicate balancing act. Over-reliance on any one company significantly increases supply risks and it is consequently important to have contingency plans in place, to counter all potential supplier failures. 6.3.3 Sustain benefits already achieved
Since the year 2000 the procurement function in the Sasol Group has delivered cumulative benefits of about R3.8 billion as defined by the Group’s strategic sourcing model. These benefits were based on the sound and rigorous application of strategic sourcing principles which have become more relevant than ever under the current and continuously developing economic climate.
74 By combining the first two levels of the HOA, Sasol is in a position to put up a formidable fight against inflation and price volatility to sustain the gains made thus far. 6.3.4 New benefits
The top element in terms of HOA is, however, the extraction of new value. Sasol has set itself a new target in excess of R2 billion, to be achieved by 2012 (Kritzinger, 2010). Kritzinger (2010) describes this as the “ticket to the dance” which is still valid today or in terms of what matters, the ticket to the boardroom seat. 6.4 DEFINITION OF VICTORY (DOV)
From the HOA, a DOV for Sasol procurement was developed in order to ensure that the function stays relevant to the Group and to support its management in tracking the overall performance of the function on a continuous basis. These DOVs also form the basis of the procurement management’s performance contracts in the Group (Kritzinger, 2010). The DOV’s are grouped per HOA and are measured accordingly. The DOV is described in Table 6.3 as per Sasol (2009: 3). Table 6.3: Sasol Procurement DOV
HOA element Foundation Key focus area Preferential procurement Enterprise development Compliance to governance Adherence to competency framework Service level agreement Supplier management strategy implementation Supplier performance against agreed KPIs Supplier management strategy where needed % of spend on terms agreement % of spend on TCO principles % of TCO track on idea level New value released Target 14/20 12/15 80% 80% 90% 100% 85% 100% 90% 60% 80% R2 billion Target date 2011 2011 2012 2011 2012 2011 1012 2011 2012 2012 2012 2012
Securing of supply
Sustaining of benefits New benefits
Source: Sasol, 2009: 1. The above targets are tracked on a quarterly basis and feedback is given to senior management. Any deviations reflected in the quarterly management reports are immediately addressed with appropriate corrective actions.
75 6.5 STRATEGIC SOURCING AND THE GLOBAL ECONOMIC CRISIS
During September 2008 Sasol found itself under severe pressure as a result of the then unfolding global economic crisis. Fortunately and largely credited to its well-established strategic sourcing process, Sasol was able to respond to the crisis immediately by engaging with its suppliers in order to lower their costs in accordance with the global commodity trends at the time. A detailed portfolio analysis had been completed on all suppliers previously as part of the strategic sourcing process and this enabled procurement to immediately engage in re-negotiations with its key suppliers. Progress made through this additional initiative was tracked and measured on a per supplier basis (Crafford, Kritzinger & Joubert 2009: 1). For this additional price reduction initiative, a target of R1400 million was approved by the Sasol Group executive committee, and it was achieved by December 2009 (Crafford et al., 2009: 1) but had it not been for the well-entrenched strategic sourcing process in Sasol procurement, such prompt action would not have been possible. 6.6 ? ? ? ? KEY LEARNINGS For a function to stay relevant, it needs to develop a vision and purpose that is aligned with that of the organisation. A function needs to be clear on its value proposition and who its customers are. A procurement function is built on solid governance, systems, skills, contract management and business processes which need to be in place to support any strategic insights. The strategic initiatives are: releasing value, sustaining of existing value and securing of supply. 6.7 CONCLUSION
Even though the newly-established strategic sourcing unit of procurement adds considerable value to the Sasol bottom line, sustaining the function and the benefits derived from its process is not easy and for the procurement function to sustain its value-add as a strategic business partner to the organisation based on the creation of TCO value alone is not feasible. It is therefore very important that a proper vision and purpose statement be developed by the procurement fraternity to which people in the function can aspire to and which can guide the function towards future success. For procurement to achieve world-class effectiveness and efficiency, it must also understand the needs of its various stakeholders and create ways to ensure that procurement’s entire value proposition can accommodate these different needs. To understand stakeholder requirements entails a detailed stakeholder needs analysis which has to be conducted through intensive
76 stakeholder interaction, such as workshops, which will enable procurement to develop its agenda of focus areas to which the function should align itself for future success. The identified focus areas are thereafter captured in a hierarchy of agendas (HOA) which assists the function in prioritising its actions. For each HOA, a definition of victory (DOV) is developed against which the actual performance of the function is measured. The result thereof is that the value released via the strategic sourcing process, is now only one of the measurement areas of procurement which as a whole can provide a true value-adding, sustainable value proposition to the organisation.
77
CHAPTER 7 CONCLUSION, KEY INSIGHTS AND RECOMMENDATIONS FOR FUTURE RESEARCH
7.1 INTRODUCTION
The purpose of this study was to explore the value a procurement function can add to an organisation through the implementation of strategic sourcing as a business process, and direct specific focus to the methodology behind the measurement of this value-add in the organisation. In order to gain more insight into the potential value that procurement can add, research was conducted on the Sasol case study. Sasol embarked on a journey to implement the process of strategic sourcing in the organisation in 1999, and today, is rated to be among the top ten per cent of procurement functions in the world as surveyed by McKinsey and Company. The research question for this study was formulated as follows: “How to create a value-adding procurement function in an organisation through the implementation of strategic sourcing and how to measure the value-add as a product of the process?” Chapter 1 focused on the research methodology that was followed in order to address the research question. The research methodology was based on an analysis of the Sasol case study, and a comparison thereof to current academic literature. The detail in the Sasol case study was obtained through an analysis of internal Sasol documentation and conducting interviews with key people in the organisation, who were involved in the implementation and further development of the strategic sourcing process in Sasol. Chapter 2 recognised the fact that a procurement function can fulfil a value-adding role in any organisation as proven in Porter’s Value Chain Model (Business Policy, 2010: 3). The literature also indicated that an organisation’s decision to implement the strategic sourcing process should be a calculated decision, based on the nature of the organisation’s spend base, due to the substantial investment required for implementation of the process. The rewards however, can be considerable, measured through the application of a proper balanced scorecard to measure all facets of the function, as a procurement function’s effectiveness and efficiency should not be limited to the application of strategic sourcing, but measured as a complete, value-adding, crossfunctional business partner. The principles laid down in Chapter 2, were then tested in Chapters 3 to 6, against the practical experience in Sasol since inception of the strategic sourcing process up to today. It was quite interesting to note the extent to which the theoretical principles, and Sasol’s experience over the last ten years correlated with each other. The one unique element to the Sasol case study, was the effort put into the development of a practical, user-friendly measurement model after it was found
78 to be the missing link in ensuring that the value-add of the procurement function was measured and reported accurately and reliably. Chapter 3 firstly examined the process that Sasol followed to come to the decision to implement the strategic sourcing process and secondly the implementation process that was followed over the initial 24-month period. Chapter 4 investigated the measurement principles and methodology, and the TCO model that is used by Sasol to measure the performance of its procurement function. The practical application of these principles was then illustrated on crude oil as the commodity with the highest spend in Sasol. The focus of Chapter 5 was Sasol’s adaptation of the TCO model of measurement, into a more practical model, today known as the Sasol Benefits Model. This model was developed after the TCO model of measurement was found to require such an enormous amount of input data on a regular basis, that the measurement of value-add in procurement became a time-consuming adversary to the actual intended focus of strategic sourcing. Chapter 6 provided key insights into the way a function needs to align itself to the strategy and vision of the organisation in order to stay relevant. Sasol had to create definitions of victory for its procurement function to review and develop all the dimensions of the function despite the substantial value unlocked by the strategic sourcing process which could lead to a narrow based focus on only this process. The aim was to achieve world-class effectiveness and efficiency as a complete procurement function, which required a properly defined functional mission and vision statement, aligned to the vision and strategy of the organisation. This research study provides insight into the value proposition of strategic sourcing, the measurement methodology for measuring the value-add contributed through the process, and guidelines for embarking on the journey of strategic sourcing. 7.2 7.2.1 KEY LESSONS LEARNT Procurement can add substantial value to an organisation
The potential benefit of implementing strategic sourcing can be between five and ten per cent of the total spend on goods and services in an organisation. In the case of Sasol, R3.8 billion in value has been released over a ten-year period. The implementation of strategic sourcing should follow a deliberate choice in the organisation to embark on this process as it requires substantial investments in skills, technology and change management. The required investment is in fact so considerable that a burning platform is usually needed to steer management in the direction of implementing this process.
79 7.2.2 Strategic sourcing is not a project, but a new business process
As suggested in this study, the implementation phase of strategic sourcing should be executed by means of a formal project but despite the project execution approach to implementation, it merely serves as the launch pad for a new sustainable business process. The new process should be documented and governed through a formal process and/or procedure of continuous improvement as it signifies a new approach to procurement in the organisation. The project phase assists in delivering the immediately obtainable value and creates an environment within which a proper spend analysis can be conducted as well as proper analyses on the first round of commodities can be made in accordance with a formal process. 7.2.3 Effect of the market and activity levels on a commodity
When measuring the effect of strategic sourcing, a proper understanding of the market in which that commodity is procured is required, and for this an independent commodity index needs to be developed. The index is a function of the true cost elements of the TCO of the commodity and in order to effectively measure TCO improvements on a year-on-year basis, the baseline needs to be adjusted by taking into account market and activity changes. 7.2.4 Value released can be once-off or sustainable
The value released by the process of strategic sourcing can be categorised into either a once-off benefit which means that the benefit will only occur for a specific time period where after the commodity will move back to the original cost level, or a sustainable benefit which means that a structural change has occurred in the TCO of the commodity and the benefit derived from it is sustainable forever. A sustainable benefit indicates a permanent lowering of the cost curve of the commodity. 7.2.5 Importance of governance in a strategic sourcing process
In order to ensure that the strategic sourcing process is adhered to, formal governance needs to be in place. In addition, the value that is reported as savings, value or benefits need to be audited annually to ensure a legitimate and accurate process, because whatever value is released through the process is removed from the budget of the end user to ensure that the full value of the benefit is reflected on the bottom line of the organisation. 7.2.6 Total functional value-add important to stay relevant
As the process of strategic sourcing becomes well embedded in an organisation, and value is released on a continuous basis, the procurement function as a whole needs to perform at all levels to ensure that the function remains relevant. A balanced scorecard approach is recommended for the development of an effective and efficient procurement function, as this method of measurement covers the financial as well as the non-
80 financial aspects of the business. The measurements need to be aligned with the vision and purpose of the function, which in turn needs to be aligned with the overall vision and purpose of the organisation. The benefit of this approach is that the true value contributed by the function is visible to all stakeholders, and the function can be viewed in its rightful status as a value-adding partner and not only as a strategic partner. 7.2.7 Strategic sourcing creates a platform from which to respond in times of crisis
Through the process of strategic sourcing, a formal sourcing strategy is developed for each commodity which entails intricate knowledge in terms of commodities. As a result, the detailed cost structures of commodities are known and an organisation can rely on this process to be able to provide the information required to respond in times of economic crisis. The platform is in place, suppliers are known and the spend pattern of the organisation is known which enables the organisation to respond in an effective manner during difficult economic times by being able to immediately re-evaluate its supply base and renegotiate with suppliers or changing suppliers if need be. 7.3 RECOMMENDATIONS FOR FURTHER RESEARCH
Given the background of this study, the following is proposed for further research to be conducted on this subject: i) A detailed analysis of the psychological impact on an organisation when transforming a function from a traditional transactional focus into a strategic function; ii) The effect of technology support when transforming a traditional function into a strategic function; iii) The change management process in the establishment of a strategic sourcing procurement function; iv) The implementation of strategic sourcing across different countries and major pitfalls to avoid; v) 7.4 The effect of low-cost country sourcing on the South African procurement fraternity. CONCLUSION
Procurement can be a true value-adding function in an organisation which can create a competitive advantage for the organisation. To extract this value requires the implementation of a new business process, and consequently a formal business decision by senior management before it can be implemented. Such a decision requires dedicated support in the form of investments in skills, technology and process engagement to make it a reality. Implementation is a distinctive separate process best served by a formal project phase, where after the new business process can be implemented in the organisation through formal procedures to which compliance needs to be governed.
81 The value released by this investment can be between five and ten per cent of the organisation’s total procurement spend and the value can be added directly to the EBIT of the organisation. When an organisation invests in, and embarks on a journey of this nature, the measurement of the value-add contributed by the process becomes extremely important as a means of proving return on investment, continuous improvement and sustainability. In order to fulfil this essential requirement, the organisation also needs to develop a formal measurement system, for reliable and accurate measurement and reporting of the value unlocked through application of its new process. For a procurement function to be truly successful and remain effective and efficient on a sustainable basis, the function needs to align its vision and purpose with that of the organisation it serves. To direct the focus of the procurement function correctly, a proper definition of victory should be developed against which the function’s performance can be measured in order to ensure that the procurement function sustains its position as a value-adding, world-class strategic partner in business.
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APPENDIX A TRANSCRIPT OF INTERVIEW MR RADIE VAN WYK
Mr. R. van Wyk interview transcription Interview held on Thursday 18 May 2010, Johannesburg Johan: Radie, you started the strategic sourcing process in Sasol around 2000. Can you just explain to me what triggered the decision in Sasol to start with a process of strategic sourcing in 2000? Radie: The main drive behind this was the fact that during the late 1990s, the oil price fell to about $10 per barrel.Top management, Peter Cox, then started the process where the whole company was sort of organised in a way to curb cost. At the time there was a company in South Africa called McKinsey Incorporated and they had a philosophy, a methodology that was applied overseas and they had recently introduced it into the South African environment and at Iscor where I was then involved in the process. When Sasol wanted to know more about the process, I undertook and played the role to introduce the strategic sourcing concept into Sasol with the objective to cut input cost out of the system. The original intent and the original spend base analysis indicated to us that it was possible to reduce the input cost by about R800 million. The R800 million was more than the net profit that the whole company made at that point. So when we presented this case to top management during the latter part of 1999, they were very reluctant to believe that it is in fact possible to take out such a huge number and we had to go back and revise our figure. We eventually came back and committed ourselves to a R400 million saving over a period of three years. The whole thing was driven by the need to make Sasol more profitable. Johan: Will you then say in your experience, is it worthwhile today to start with a process of strategic sourcing in the absence of a case for change? Radie: I would say it is almost impossible. I mean you have to have either a burning platform, which Sasol had, or you have to have a compelling case for change. In both cases you have to understand and know what your spend base and absolutely depending on the processes that you follow at the time, the possibility, the potential varies in my mind between 2 per cent and 15 per cent. In that sense you have to be able to define those figures in the sense that you must be able to prove or put a compelling case to management on the value-add in it for them. Because we have to understand it’s an expensive process. It concerns consultants, like the McKinsey’s of the world,
87 and it concerns implementing processes within the company which needs some different skills at different levels, mainly or mostly at the much higher level that’s normally used in a procurement environment. So it is an expensive process but the turnover or the benefit that you get is big; for Sasol it was in the region of R10 to each R1 you spend. So for us to be able to gain R400 million we were spending in the region of about R40 million. Johan: If you look at the evolution then in Sasol of the procurement function, how can you describe it when you started around 1999/2000 up to what we have today? Radie: Well, during the late 1990s Sasol was a very traditional environment where most of the businesses were decentralised and purchases were done at the business units. Meaning, there was very little economies of scale and nothing, if at all, economies of skill. So in that sense when we started this process it was purely a price-driven environment where value-adding was very limited. We had to grow this process through the strategic sourcing process to an environment where Total Cost of Ownership is the main drive and the criteria that we were using to determine whether we are successful or not. In that process the two fundamental principles that we were looking at, which was not present in the old Sasol environment, was economies of scale where we could group the spend of the company together, and by having bigger margins, bigger leverage on our suppliers in terms of our spend. That was the one area we had to look at. The others were economies of skill, and cross-functional collaboration where we brought technical people and the production people into the process and jointly as a working community, identified opportunities. Johan: Can you then describe for me the strategic sourcing process? You mentioned ideas, you mentioned end users, and you mentioned cross-functional collaboration. Radie: Sasol was organised in silos. One silo is maintenance, the other silo is production and the third silo is procurement, and those silos were individually organised in such a way that they had their performance criteria, which was independent of each other. And it was in some cases actually working against each other. What we did was, we started to follow the cross-functional collaboration process where we brought people together in teams and we were working in, best people from procurement, put them together, do calculations and they identified improvement ideas. First of all they identified ideas in and around the work environment. They quantified those ideas by judging and adjudicating the possibilities of the opportunities and putting value, rand value to it. In that process they were setting inspirational targets in the sense that they would say we’ve got this specific commodity and this is our spend base. Let’s say we were spending R200 million
88 on it and they would come up with the figure saying, on the R200 million we believe there’s a 10 per cent stretch possibility. 10 per cent on that is R20 million. And by having that stretched target, you send the people away and they do some research. They generate ideas in collaboration with all the stakeholders in the process. And after adjudicating and valuing the ideas they come up with a figure that was then measured against the 10 per cent. And in some cases, actually most of the cases they exceeded the 10 per cent by a long way. Johan: How did you go about letting people buy in on such targets? Radie: Well, in a company like Sasol where everybody believes it’s a well-run company, which it still is, talking of a 10 per cent improvement is exorbitant and people tend to not take it seriously. So what we did was to slowly but surely take one step at a time and our slogan or our belief at the time was ”success breeds success”. So you start by taking an environment where, and you focus on the environment, and you actually deliver. The ticket to the dance that will secure your success is to deliver on promises. So if you made a promise, you must ensure that you adhere and that you deliver on that promise. And if you can exceed the promise, even better. That’s why I said; in most cases we actually exceeded the original promises. And by doing that, we were drawing attention from all over the company where people said, but gee whiz, this thing can work. And if it’s working for one area, then the immediate question is why is it not working in a different area or in another area. Because whether we liked it or not, not everybody in the company was very excited about this process and they simply didn’t believe us to start with. But gradually we had to prove to people that this process is in fact well defined and it’s working well, and by implementing ideas and making sure that the ideas are well implemented and well structured, and workable, we slowly gained access to more and more areas which eventually became a way of life. Johan: The decision on where you start, obviously you can’t tackle the whole spend base at once. How did you go about to determine which commodities to focus on? Radie: The traditional Sasol was an environment where we had little feel for actually how much we spent. So the very first place that you start is to determine and find ways to do a spend analysis. Understand where you spend, how much you spend and with whom you spend it. Because unless you know that, your opportunities become depleted and you have no real ground of capturing the economies of scale or economies of skill. Once you have a proper, well-defined, flexible spend base which you can rely on, then only do you start by saying okay, which are the biggest, where are the areas that I can improve easily and where are the low-hanging fruit. So we started really by
89 identifying the low-hanging fruit. By low-hanging fruit I mean what was easy to implement and what was the best, the highest yield that you could receive. By doing that and understanding that, we were able to very easily prove to people that in fact there is a tremendous opportunity. Johan, Was it an easy process in Sasol to analyse the spend base? Radie: It was extremely difficult and the main reason is there was no standardisation in the Group and people bought the same things from various businesses, not even understanding that they bought the same thing. The suppliers were taking advantage of that because they were seeing that we were buying the same stuff, but they were not telling us. So we had to go back to the basics and the basics mean that we had to start with a standardised procurement definition of what we buy. And in that sense we embarked on a UNSPC process and methodology to standardise our purchases, so that wherever you buy in the company, the commodity will be described in the same manner and the spec would be standard. And it was only after that, that we started understanding and fully be aware of how much we spend on a specific commodity. And it was amazing what we learnt over the time. The more and more accurate the information became, the more we learnt about ourselves in the process. Johan, You mentioned earlier, the end users and the functions within Sasol. What about the suppliers; what role did they play in this process? Radie: The whole methodology of strategic sourcing is a triangle type of thing where you have three parties playing a role. The one is procurement, the other one is the end user and by the end user we mean maintenance and production. The third party, equally important, is the supplier. And in the areas where we had the suppliers actively participate, the results were astonishing. Not only for us, but for them as well. They also benefited from the process, and the figures I quoted to you earlier did not even include the supplier part of the improvement. My personal belief is that they probably benefited equally to what we benefited. So their participation in the process was vital and is still vital. Remember total cost of ownership involves all the cost in the supply chain. It also involves the whole lifecycle of this product. And in any lifecycle of any product the supplier plays a major role.
90 Johan: During the first few years, where did the bulk of the value come from? End users, suppliers or the procurement environment? Radie: Immediate, low-hanging fruits usually came from the commercial side of the business where we were able to utilise our economy of scale. And that was probably 30 per cent of the total benefit, but at least we had something to show for our efforts. But over time, as the process matured, it was evident that the bigger, by far the bigger portion lies in the utilisation of this commodity. Either by production people or by maintenance consumption. So by adding the end users into the process we benefited in the end about two thirds of the end results. Johan: And value from suppliers’ side? Radie: Well the value of the suppliers’ side was also substantial, but not as big as our own internal value released. But the suppliers played a role in efficiencies in terms of supply and in terms of transport and those things, and with their expertise in terms of the commodity that they sell. Giving us opportunity to play around with some of the products and identify economies of skill and scale that we could utilise. Johan: You mentioned that Sasol started off as a buying organisation totally decentralised. Will you say by embarking on this process we were able to bring procurement to the Board room of Sasol? Radie: Well, in the end it happened, it so happens that this becomes an extremely important part of the Board room and very few of the purchasing strategies that’s currently applied in the Group, I should say all of them, are approved by the Board, directly or indirectly, through a process that we call stakeholder committees. Those stakeholder committees are chaired by mostly Board members of the company. So they take first-hand active participation in this process and they in the end approve the strategies that we put forward. We’re at the point where the company will not put forward any strategic initiatives and/or strategic goals during the year that we are not playing a part of. Johan: Radie, in order to be part of the Board room it is crucial that you are able to measure your value. You mentioned that the process was triggered by a commitment of R400 million. What role did measurement play in this process?
91 Radie: Well that’s absolutely crucial that indeed we are able to consistently prove to our constituency that the value that comes to the table is indeed being seen on a bottom line. So for that reason we had to develop our own set of criteria that a saving or a benefit of the TCO improvement had to adhere to. What we did in the first year, we applied those measures and we brought in an independent auditor from outside the company to audit those figures and to indeed indicate to our Board that this is in fact the case. So we went through a rigorous process firstly to define what a benefit is, to understand and define and declare where that sits on the bottom line, and then bring in independent auditors to verify that. But without a set of criteria that is non-negotiable, you will not be able to define the value that this process brings, especially if you spend quite a couple of million on the process. You have to prove to people that in fact you are yielding your ten times or whatever the case might be. Johan: So what you are saying to me is to be part of the Board room agenda, you need to be able to talk rands and cents. Radie: Well, rands and cents is the only thing that counts when the bottom line is expressed. And you must be able to prove to everybody in the company to what extent you’ve impacted the profit of the company. Johan: Is it correct to make the assumption that if a function cannot prove its value proposition in terms of rands and cents, you will not necessarily get a seat or be on the agenda of the Board room? Radie: Well, it’s going to be very difficult. This was in my mind the main reason for people or the Board taking us seriously, in that we could start defining our value proposition and not only defining the value proposition but also implementing on a sustainable basis these ideas that were developed by this process. And we were not only able to put that into rands and cents, but we were also able to ensure that over time the sustainability is there and that we’re not falling back into old habits. Johan: You mentioned benefits. What is a benefit? Radie: A benefit means different things to different people. But it’s actually sustainability. First of all it’s the TCO concept. Total cost of ownership, meaning where do I stand in this year versus where should I be the next year? And it’s based on a baseline. So you create a baseline in year 1 and the
92 baseline is developed through the process that I’ve explained previously, TCO and we use the TCO concept. Now you measure that same baseline ongoing and next year you make adjustments for volume changes and for index changes, what the market did to you, to define the second baseline versus the first year baseline. Those are the comparisons. Then what you do is you measure the actual TCO versus the adjusted TCO and that difference is then sustainable improvement, sustainable savings, sustainable benefit. Johan: Radie, you’ve been a consultant now since you’ve left Sasol about four years ago, to various companies in South Africa. The companies that start strategic sourcing today, are they using the same methodology? Radie: Exactly. The principle that came from this methodology that McKinsey brought to the table is after many years still intact. They’re still applied and most of the Fortune 500 companies that I’ve seen over the years apply this process in one form or the other. And most of the companies will tell you straight away that their survival is actually based on the fact that they had the guts to embark on this process. Johan: According to you, what is the biggest flaw or biggest problems that you will encounter in practice? Radie: First of all, to be able to track TCO properly, the harmonisation of the information is of vital importance. Now when we started in Sasol in 1999, we had fourteen different ERP systems. And that in itself created a tremendous back log in the accuracy of information. So we embarked simultaneously on a process that we called data harmonisation. The first step there was to reduce the number of ERPs to four, which improved the figures and the accuracy of the figures substantially. So the biggest problem we had was to have information that you could rely on, that you could consistently make decisions from. To be able to do that you need information that’s accurate and available. Now another problem we had is most of the information was available, but lots of it was outside the systems. Despite the fact that we had fourteen systems, a lot of information was sitting on private laptops and PCs all over the place. So we had to find a way to get that information into the systems in an elegant manner in order not to have a too cumbersome process in getting the information. Johan: What did you do in Sasol to get around all these complexities?
93 Radie: Well, while we were struggling to get the information accurate and to be able to track TCO in its fullest form, we couldn’t sit back and do nothing. So we had a process, an intermediate process that we implemented that we called the Benefit Model. Meaning that you could track ideas but you didn’t have the full impact, you didn’t see the full impact of TCO. But at least you could measure the value of the idea that you implemented. Maybe we should talk about what TCO means. Let me give it to you quickly. TCO basically consists of four buckets and those four buckets represent the whole supply chain or the whole life cycle of the commodity. Now one of the buckets is an opportunity bucket, which is extremely difficult to measure in the sense that it measures the efficiency of a specific product. Now measuring efficiency is extremely difficult if the information is not readily available and it puts your process under scrutiny. So we sort of stayed away in the first couple of years from reporting any of the ideas that sat in that bucket. We were only focusing on the other three buckets, which were easier to measure. The direct and indirect cost bucket. So we had the direct cost bucket, indirect cost, related cost bucket and the fourth bucket was opportunities. So we started every time we ran a value team at the direct cost bucket because that was more freely available. Indirect cost bucket was, if available, mostly available through the supplier or through an unofficial source. Then the related cost bucket was also part of supplier market information. As you build from bucket 1, to bucket 2, to bucket 3 you improved the accuracy of your information going forward. And you could, by having those three buckets, prove sustainability easier. Johan: What was the original response of the people out there when you started putting forward these benefits that are based on a TCO principle and, let’s be honest, it does not correlate one hundred percent with your financial statements because the methodology differs. Radie: What’s an important one is that the financial way of measuring and the commercial way of measuring become a bit difficult. Not difficult in the true sense, but it’s different I should say. No financial system measures opportunity. No financial system really measured indirect cost because it’s a supplier thing. Johan: Yes, only the result…either lesser income or… Radie: Exactly. So the general argument or the general comment we usually had was “but I don’t see these benefits on my bottom line”. Now it is true that it’s difficult or very disguised in the sense that you don’t see it straight away, especially where people overspend their budgets. They will
94 consume these benefits very easily and it falls into the cracks and a person will not accept that you come to him and say “I’ve saved you R10 million”, but if he looks at his budget, his budget is overspent. So we had to create an environment where people would allow us to go into their business, look at their figures, and from a commercial perspective indicate to them where they’re losing money and that indeed if we did not save then the money, their budget would have been R10 million further in the red. Now that is very true in a much matured environment, but at the time the environment wasn’t that matured. So we had to create an environment where maturity was growing. And what we did was we actually, through the process that we implemented, and through the cross-functional principle, we were taking all the ideas to the end users to finally sign on to accept, not only value that we were quoting, but also that they would help us to implement. In fact in most cases they were the implementers themselves. That process helped us to quantify the savings idea initially. In the end we understand exactly how much was saved. Johan: Radie, in your experience is it possible to only have the effective environment built on strategic sourcing? Radie: No, I don’t think so. Johan: So what else did you have to do in Sasol to ensure that you have a very effective supply chain function? Radie: Like I said in the beginning, process only buys you a ticket to the dance. So once you’ve proven to your company that you actually can do and that you actually can perform and that you actually can deliver on your promises, then they will give you an opportunity to do some of the other things. You must remember what I just told you about strategic sourcing is only one part of the supply chain environment. Supply chain consists of a whole host of different functions of which we’ve dealt with procurement per se. so what we had to do is we had to create building blocks, and the building blocks were put in place to enable us to over a period of time deliver against a variety of deliverables that we agreed on. That was the first thing. Second thing, was demand management that we had to deal with in the sense that demand management was actually our interaction with the end users. So in that sense our delivery, our performance was essential and the reason I say that, is that there was no way that we could save R400 million while our service to our end users was of such poor nature that they would rather do it themselves. So we had to sort of, in a joint approach, put the value on the table and from that value then, turn our attention to the other areas of procurement, or supply chain. Meaning that we had to address our process, meaning that we
95 had to look at the efficiency of how we do things. For instance, we decided that our delivery would be on time in full, meaning that whenever you end user wants something, you deliver to him, on the pre-determined date the full order so the end user can perform his duty. It also means that through the whole company we had to develop a whole set of performance criteria. This criteria was derived from the question: “How will we know when we are performing at a world-class standard, two, three, four, five years down the line?” We also understood that this process is not a process that you can implement overnight. It was a journey, it’s not a hundred meter dash, it’s a marathon that we started, and this marathon started with the TCO process and the value teams that we started in 1999. So over time we had developed a set of performance criteria and we also understood that once we arrive at the level which was acceptable to the company, we had to have a number of governance initiatives and documents and processes what would govern the company as a whole. Remember I said when we started: Sasol was a group of individual businesses. Over time that’s grown and merged into one big family where the governance is done at a corporate level. So we do governance at the corporate level but the execution still sits at business level. Johan: Radie, you explained to me the whole process now of establishing strategic sourcing, the journey in Sasol. What will you say today; you’re working with many companies outside Sasol today, what are the things that you need to watch out for before you start destroying the value created by strategic sourcing? Radie: Before we get to what’s going wrong, I just want to tell you for us, for any company to sustain this, to start this process and sustain this process top management buy-in is vital. Without the CEO’s acceptance and acknowledgement of the necessity, sorry, don’t even try it. Now, many companies yes, it’s true that may companies go through this process and they end up in an area where they started. Now, there’s basically in my mind two reasons for it. The first reason is, most companies consider this to be a project. Now a project has a beginning and an end date. So people would ask the questions consistently: when are strategic sourcing teams going to stop, to cease to exist. It’s a consistent on-going sustainable process and as long as this company exists, that philosophy and methodology must be applied. That’s the first, main reason for ending this process or grinding to a halt and going back to the original attempt of just focusing on money. Secondly, if the company runs out of ideas, when the technical ideas and the commercial ideas are not forthcoming any more, the team themselves lose faith in the process and they start losing interest. That’s the second one. The third one is the cost structure. The original structure, where you only have commercial people in, is much cheaper. It’s much more expensive having a cross-functional structure there with high-level, highly-paid, specialised people. Now the pressures in the company consistently drive the cost down. So what happens in the company, instead of having a central-led
96 approach where the efficiency is at the maximum, they start driving cost instead of TCO in their own environment? Johan: You mentioned here the structure is more expensive. Do you need to re-wire the people? Radie: Well that’s where the expensive part comes. You must understand you have to grow an organisation from a traditional buying environment, to an environment where you leverage you buying power, you leverage your cross-functional collaboration skills, you leverage your ability to utilise different people skills and bring them together. So you’re thinking of an individual in that process which is completely differently wired and trained and equipped to handle the new environment where the positional power is gone. It’s now becoming a personal power thing. And I mean positional power is the original environment that Sasol was in, where we had lots of processes and authorities that determine our behaviour. In this process there’s none of that. But for the governance at a very high level, the rest of it will be determined by the skill and the capabilities of the people in the teams. Their ability to take people with them, the ability to excite people about the future, their ability to extract ideas from people where they’re reluctant to give ideas. Meaning that the environment, the mature environment that you are now growing and living in, is the environment where you will extract value for the company. Johan: What were your biggest challenges in the beginning? Radie: First of all, the belief that a department, the traditional department of procurement, does or doesn’t have the capabilities to impact the company to the extent that the methodology requires. And it is true in the sense that if you want to do it with the people that currently sit there: you’re not going to do it. So you have to find, you have to spend money to find people, to bring them into the process so that you can actually demonstrate to the company that you can add value. So that this belief, that a department like procurement can add those big numbers that are usually quoted as an objective for this process. That’s the first one. The second one is most businesses will question the fact that you want to improve, they all have the belief that the company is well run and now you want to, as a procurement environment, want to come and tell them that there’s 10 per cent, possibly or 10 per cent to 15 per cent improvement on that. They fail to understand that. And the third one is, it’s a very labour-intensive process. And the labour part is you need people, you need the best people from the business, not the sick, lame and lazy. You want the best people from the business to come into this process to jointly collaborate, you collaborate with this methodology and utilise this methodology to grow the company and to make possible these benefits. And then
97 another one is people tend to think that the procurement people, Maintenance for instance, procurement is now coming into their environment and procurement thinks that maintenance is coming into their environment creating the impression that you disempower people. But it’s actually the opposite. You empower then to make their own decisions, but their perception in the beginning is that you disempower them and you allow people to tread in different areas where they don’t belong.
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APPENDIX B TRANSCRIPT OF INTERVIEW WITH MR CLEM SWANEPOEL
Mr Clem Swanepoel interview transcription Interview held on 17 May 2010, Sasol Head Office, Johannesburg
Johan: Can you explain to me how you got involved in strategic sourcing around 2000? Clem: I was part of financial and from the financial team I got involved in the strategic sourcing. I think the main driver there was the fact that most of those activities were with Synfuels and I was living in a Synfuels environment, Synfuels Mining environment. Johan: Why did they bring you onto the team? Clem: Well, the fact of the matter here was that there was a lot of value in this. You know, if you’ve looked at the promised rand values that were in excess for the first year, I think it was approximately R100 million and it was stepped up year-on-year to quite substantial amounts of money. And the promise was made to the Group executive committee in Sasol, our highest level of reporting, and we had to track that very vigorously to ensure that we deliver on the promises that were made. Johan: What model did you decide to use to measure the value? Clem: Well, to ensure that we do capture all the benefit and make sure it adds value to Sasol, we’ve decided on a model called TCO – total cost of ownership – where we’ve looked at direct and indirect cost on a year-to-year basis. You have a baseline and the baseline had to be adjusted for changes, to ensure that when we increase our input, it is captured accordingly. And at the other end there are certain market drivers as well, the indices. You had to allow for what the market indicated. So if you beat that, it shall be measured as a benefit. Johan: You say volume adjustment. Please expand?
99 Clem: We have a certain amount of white product that we push through the Sasol system every year. If we do more of that, the variable cost that is associated to that should be adjusted before you have a proper baseline. If you increase on that unrelated cost, you need to ensure that your model caters for all the variable portions to include that. The same when you increase your throughput and you need to increase your transport in order to deliver the product, you need to cater for the variable cost portion. Johan: What did you do in a case where you establish a new plant or decommission a plant? Clem: In terms of new plants, decommissioned plants, you had to adjust your baseline to reflect that and all the costs what were attached to that had to be removed from the baseline. Johan: Did you experience any problems with the measurement? Clem: There were quite a few things that we had to overcome. I think the biggest here was the availability of data. That was quite a substantial problem. Also, if you look at the financial side, we had not always used the financial information to do the tracking. There was quite some sort of reconciliation that had to be done between the payment cycle and the financial reporting in terms of income statement and balance sheet. It was quite tough in certain instances because many of the tracking that we did, was done purely from payment. If you look at the payment cycle, it doesn’t always fall straight into the income statement. So if you have to compare that side to your income statement, it was a tough task. Certain of those things had to go into your inventory, it went to capital projects, it went into various areas that were not directly related to pure cost on your income statement that you had to adjust to make sure that we do cater for your benefits. Johan, So what you’re saying is that your budget escalation and the true commodity did not add up? Clem, They didn’t tie up. Johan, If I understand correctly, from a TCO measurement point of view, the main issues were the availability of data and systems. Getting the exact data for a specific commodity and tying that back to your financial statements?
100 Clem: I am comfortable with that. Johan: What did you then do to overcome this issue? Clem: What we did is to build an excellent model where we’ve distinguished between your sustainable benefits and once-off benefits. The sustainable benefits were split into idea benefits, price containment benefits and TCO benefits. The fact is we had to make it auditable as well because if you start tracking, you need to have good definition and guidelines to ensure that whatever has been claimed can be audited. For this reason we developed a tracking model. Johan: Clem, if you could forward me that model, I’d appreciate it. Clem: Will do. Johan: The data and availability. So, you developed a new model that you use for tracking of the value release: to cater for the issues or the complexity of establishing a TCO. Clem: Yes, we tested the market to see if specific models were available that you could use and apply. We were unfortunate with that. We had to develop a model where we catered for the tracking, where we then listed all the ideas and in which bucket they would fall from the TCO model. Each team had access to this where they report on a month-to month basis. Johan: But the measurement of those ideas was still in line with the principle of TCO. Clem: Absolutely. I mean that is why I say, in terms of auditing purposes, we had to agree to the rules for each and every benefit reported, whether it was a sustainable idea, the volume adjustments had been done, the correct indices had been used, the direct cost had been taken into account. And, as I said, on an annual basis we involved the Sasol auditors for each of the teams to ensure that they did apply the rules correctly and we got an actual audit report reflecting the correctness of the benefits.
101 Johan: Is it possible to link TCO measurement to your financial statements? Clem: Johan, we went through quite a huge exercise the one year to ensure that this was relevant, especially in the Synfuels and Mining environment and I am comfortable to say that 100 per cent of those have been taken back into the financial statements. The matter of the fact is that all of that will not necessarily reflect on your cost side some of those will be reflected in your balance sheet as well as your cash flow where you build certain plants and where in the depreciation cycle that will be reflected in your costing. In terms of that we had sign-off from our financial side, on the Synfuels as well as the mining cycle, where they’ve actually agreed that the benefits can relate back into your financials. Johan: What do you need to keep in mind when you do the reconciliation between the value released and the financial statements? Clem: You need to consider the market index used, the volume adjustment and the assumptions used in the budget process. The budget does not necessarily use the same index and volume adjustment. Further, do your financial statements also not cater for index adjustment and value adjustment? Our financials are also not inflation-based, and in both cases those are the two elements that you use to adjust your baseline from a TCO point of view. Johan: The value claimed via implementing strategic sourcing; will you say that is a true reflection? Clem: I feel comfortable that it is a true reflection in terms of the ground rules developed. Johan: You referred earlier to the principle of once-off versus sustainable. Can you please define “onceoff” and “sustainable” benefit? Clem: The once-off benefit is not a baseline-related benefit. It is a benefit that happens where there is negotiation, for example in Sasol’s German business many years ago where we had what was referred to a “spot pricing”: when prices were low we’d buy, and as prices went up, we’d sell it again and in terms of that we would claim a benefit. That is not a sustainable benefit.
102 Johan: And that only happens once. Clem: Absolutely! The risk is that you might claim that it is sustainable. You will have to do the adjustments; one year you might have a benefit, but the next year you might have a huge loss. Johan: And the sustainable benefit? Clem: The sustainable benefit is where, year-on-year, the baseline adjustment is done and on an annual basis Sasol has the benefit of the benefit. It will run forever more. Johan: A practical example? Where, for example, a specification changes. Where a certain specification, where in the past you utilised a certain level and in terms of the new product you require far less, but you continue using that further more.
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APPENDIX C TRANSCRIPT OF INTERVIEW WITH MS THIANA BORNMAN
Ms Thiana Bornman interview transcription Interview held on 18 May 2010, Sasol Head Office, Johannesburg
Johan: What is the role of the Procurement Centre of Excellence? Thiana: It is a strategic role where we give direction to the broader procurement community within Sasol. We are also responsible for the procurement governance and training of the procurement fraternity. Johan: What do you do mean with procurement governance? Thiana: Governance with regards to specific procurement policy, procedures, work instructions and so forth and then also the benefits measurement will form part and parcel of that governance. Johan: What will you say is the key elements that need to be in place or what you need to consider before you make that decision to embark on a process of strategic sourcing? Thiana: Johan, to me it is extremely important that you do a spend analysis to fully understand what you are dealing with, what you are buying, where you are buying it from and from whom you are buying. Without a proper spend it will be extremely difficult to make any decision because that to me is the whole foundation of the strategic sourcing process. Johan: Please explain the process that you followed in 2000 in Sasol, to understand the Sasol procurement business?
104 Thiana: With the spend analysis you basically start off with gathering all the spend throughout the Sasol Group and then to build a proper spend database for a specific financial year. This will then form your baseline going forward. Once you have that full spend database, you can then start analysing the spend and categorising it into logical groups in order to understand what you are buying and who are the different Sasol entities buying all these groups and services in that database. Based on that information, you can then make certain decisions in terms of whether it is feasible going for strategic sourcing or how to structure your strategic sourcing environment based on the logical clusters of goods and services. Johan: I take is that this then forms the basis on how you determine the commodities that you would like to focus on. Thiana: That is correct yes. Johan: In Sasol today, what percentage of the spend base are they currently managing from a strategic point of view? Thiana: Johan, it is in the region of 60 per cent of total external spend at the moment and obviously going forward, we would like to achieve at least 70 per cent of the total spend based on strategic sourcing principles. Johan: In my interview with Radie van Wyk, he told me that when Sasol decided to take the route of strategic sourcing, the Group executive approved a potential business case of R400 million of value to be released. Thiana: That is correct. Johan: And there was a lot of time spent in measuring or establishing the ground rules for how to measure this value? Thiana: Yes.
105 Johan: How important is it to measure the value released by a strategic sourcing process? Thiana: Johan, for me it is extremely important to measure, because if you do not measure, you would not know how well or bad you are doing. Apart from that, it is also important for management information that you know how you are doing, what is the value that you are extracting from your external spend and then also it is very important to inform your stakeholders, because strategic sourcing is supported by senior management group-wide in Sasol, and it is extremely important that we inform them on a regular basis in terms of how good we are doing in terms of the targets that we set on an annual basis. Johan: Can you explain the process of measurement of the strategic sourcing value release? Thiana: Here we look at the Sasol Benefits Model. Johan: Can you define benefits and what does that mean in practice? Thiana: Firstly, we categorise benefits in terms of sustainability or once-off benefits. Sustainable benefits are then further categorised into TCO benefits, idea-realised benefits and cost-containment benefits. The main difference between these different types of benefits is to what extent you know the six requirements that we set for this module, to which extent they need all six of those requirements or only a few of those requirements. Johan: Could you please name the requirements? Thiana: The six requirements that we indicate in our benefits model is: we need an index, and economic index. We need a baseline. It must definitely be sustainable. Then we need an activity level. In the case to TCO measurement, we need a TCO tree and then also it must be MECE. MECE just means no gaps or overlaps. Based on these six requirements, if we look at the different types of ideas, TCO for instance; TCO benefits need to adhere to all six requirements. Johan: Can I then regard TCO measurement as the highest level of measurement?
106 Thiana: It is the highest level of measurement, but it is also the most complex. Johan: Yes, that is like when you do TCO measurement, you are right there on top. Thiana: Yes, normally it is a process where you migrate for instance from price containment toward TCO measurement. Johan: What do you mean by “price containment”? Thiana: For price containment for instance, you need an index. You must have a baseline and it must be sustainable. These are the only three requirements that are necessary for price containment benefit measures. Johan: Thiana, how did you derive or develop this model of measurement? Thiana: As far as I understand, when we started off with our measurements, there weren’t any benefits, there weren’t any best practices we could build on and this was developed in-house, fit-for-purpose for our strategic sourcing environment. Johan: Are there any specific limitations to this way of measurement? Thiana: As with everything, there are certain limitations in terms of our current measurement or measuring model, but the benefits by far outweigh the limitations. Some of the limitations currently is that TCO measurement is extremely complex and a lot of effort and back-up information and data is required in order to fully populate that TCO tree and to then quantify it and the opportunity bucket cost elements in itself is also very difficult to quantify. The index is lagging and therefore you will only see the real impact of a change in your economic indices two to three months you know since it happened. As I said the benefits definitely outweigh the limitations. I fully support the measurement, even though there are certain limitations in terms of that. Johan: How much value did Sasol report up to now, since 2000?
107 Thiana: Since 2000 up until financial year 2010 the total benefit reported is in the region of R3 billion and approximately 70 per cent to 75 per cent of that is sustainable. Johan: Thank you.
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APPENDIX D TRANSCRIPT OF INTERVIEW WITH MS CHRISTA-MARIE DU TOIT
Ms Christa-Marie du Toit interview transcription Interview held on 17 May 2010, Sasol Head Office, Johannesburg
Johan: Christa-Marie, can you please state me your name and your position in Sasol. Christa-Marie: My name is Christa-Marie du Toit. I’m the Specialist Commodity Indices, responsible for updating and compiling commodity indices for benefit purposes. Johan: How many years of experience do you have in this field? Christa-Marie: In this field, approximately 11 years. Johan: What is the role of the Centre of Excellence on Indices? Christa-Marie: My primary role is to update on a monthly basis the difference indices, prices, exchange rate that the procurement people use and the commodity people use in their contract price adjustment, as well as in strategic sourcing with regards to the calculation of benefits. How we compare to what the market is doing. Johan: How will you define then the independent index for a specific commodity? Christa-Marie: An independent index would be something that nor Sasol nor the supplier has any control over, so it’s independently published and everybody has access to it. You will go and have a look at your cost drivers of a commodity, see what the relevant importance of each of those cost drivers in your total cost is, get the weights of importance and then you will go and find an independently published index that will measure that cost. With those two elements, the weights and the independent indices that you get, you compile basically a composite index which you call a
109 commodity index with which you can measure the cost movement of your commodity, either up or down. Johan: So in order to estimate an independent index you need to keep in mind your cost drivers of the commodity and then you say you need to find the relevant index. Christa-Marie: Yes, and typically when you work with international indices when you’ve opted for an imported component in your commodity, then you will have to look internationally for their indices and you need to take into account the exchange rate. It will also be part of your formula then. Johan: How do you ensure that you don’t end up with double counting where you compile an index? Like, for instance, certain items that are already captured in PPI, the same cost element may be reflected in another index. Christa-Marie: It’s when you do the calculation of the composite index. You do a mathematical calculation of your formula so that you can isolate the different components and put them together to get one weight from that, that’s not reflected in another portion’s or element’s weight. Johan, Say for instance in a case where a supplier wants to ring-fence a specific cost item like the escalation takes place on a yearly basis and now you want to ring-fence a cost element which you would like to escalate only on a monthly basis. Christa-Marie: When you do that you do it on contract basis and that portion of your formula you will adjust, the rest you will keep fixed. You won’t adjust so it will be multiplied with 1. That is in contract price adjustment. In strategic sourcing or TCO we want to measure what the market is doing and taking a fixed portion into account there won’t be right, because then you won’t see your benefit at the end. You need to take that fixed portion out of the equation and make your weights adding to a hundred percent again to see what the market is doing and then compare that with what you did in your contract price adjustment, you will see the benefit. Johan, Are we actually saying that your contract adjustment versus the measurement of total cost of ownership within strategic sourcing is not equal?
110 Christa-Marie Yes, you will typically take out the fixed portion. Johan: What are the main issues or shortcomings of this method of TCO measurement? Christa-Marie: From the index point, the first one in my mind is you don’t always get the right or the specific index that you want to measure the cost with. That’s the first one. The second one, in these indices, because you want the independently published index some of them lag two or three months or more sometimes and that creates problems because you want up-to-date information. And your suppliers don’t always understand the fact that these indices are measured on a lagging basis. Johan: Okay, so in practice what happens then is, for instance, a supplier comes to you with a specific escalation, for instance labour, his labour cost already went up. But the labour index in itself doesn’t portray the increase. Christa-Marie: Yes, because typically in labour’s case, labour negotiations yearly happens around July, but it always lags a month. Those negotiations can take forever. So the actual index is only adjusted by October/November. But the supplier wants the adjustment already from July and the index won’t reflect that adjustment. Another one typically is table L1 or L2, which is the index for road freight. That index, because it’s a composite index some of its parts are not known up-to-date so that typically will lag two to three months. Johan: Okay, so what you are saying to me is then, from a contract point Sasol may have already granted an increase, but from a TCO measurement point of view the actual index adjustment for the TCO baseline is out of sync. Christa-Marie: Yes, that could easily happen. Johan: So it may look like a de-saving but in the meantime it’s only the market or the index only needs to catch up with the reality with what’s already happened in the market.
111 Christa-Marie: That can happen. What also can happen is sometime indices get revised. So the contract was adjusted to a certain index and the index was revised in the meantime, so the TCO benefit measurement will show something else because the index has been revised. You get that problem as well. Johan: These principles that were developed, have you rolled this out overseas? From a practical point of view, will you say applying this internationally is different to applying it locally? Christa-Marie: I don’t think there’s a difference. The principle stays the same. What you can do here, you can do in Germany. You can do it in the USA, you can do it in Italy. We actually already did that. If you’ve got indices in South Africa, you will get indices or processes or exchange rates in another country as well. Each of these countries publishes these indices and the principle stays the same. So what you can do here, you can do there. When you do it from here onto an international base and you want to convert it back to South Africa, you will always need to take into account the exchange rate that could have an impact on your figures. Johan: How do you go about in Sasol in managing and providing this information to the strategic sourcing environment? Christa-Marie: The Index Centre of Excellence will typically work with the strategic sourcing teams, understanding their commodity, the cost drivers. Then the Index Centre of Excellence will go and compile this formula or this commodity index, this composite index and all of these indices of commodity, of all the strategic sourcing teams then are put together in one model to ultimately get an average market index. To say this is the PPI or the Producer Price Index for a Sasol and you can obviously break that down to just looking at Logistics or Mechanical, a Mechanical index or Electricity and Instrumentation or Process Materials. But it all gets weighed then with spend, the annual spend to get a yearly PPI. Johan: Tell me how many indices do you have? Christa-Marie: Yes, currently we’ve for the Sasol Procurement Index Model. It has about 250 odd commodity indices in there linked to about, I think 100 to 135 different indices.
112 Johan: Is this web-based? Christa-Marie: Yes, on a monthly basis it will be updated and then published on the web for their access. Johan: Now before Sasol embarked on strategic sourcing, what did they use to determine the efficiency and effectiveness of their sourcing? Christa-Marie: That’s difficult to say, probably just budget. By looking at the budget, did we make the budget or not. I don’t think they actually measured, I don’t think they actually measured their efficiency to buy. What they did on contract price is three quotes or they just negotiated, in many instances accepting what the supplier says. Johan: From a sustainability point of view, do you have any specific measures in place to make sure that you don’t lose that value? Christa-Marie: Yes, you need to keep focus and make sure that you’re better than the average on a continuous basis. Johan: The process of establishing an independent index is actually a scientific process and it’s not being influenced on a monthly basis by strategic sourcing people. Christa-Marie: Yes. Obviously you set the index and that will stay the same for at least a year. You can’t change it every month. It doesn’t work like that. Johan: Say for instance something changes, how do you go about it? Christa-Marie: If something is structurally changed, then you need to go and have a look at your index, if it’s relevant or not and then you can change is to become more relevant. Johan: How does the governance process then work?
113 Christa-Marie: He will contact me and I’ll do the analysis to see if that’s really true or not. We will have discussions on why this could have happened and then I will try and compile a new index that they need to take to the Steercom for their approval. Johan: What’s the Steercom? Christa-Marie: The Steercom, is the executive committee that needs to approve these strategies of theirs. Obviously the commodity index and measuring benefits is part of that strategy and they need to sign that off to say this is what happened. There’s the structural change that took place and we need to adjust the index. Johan: And it is also part of your audit process? Christa-Marie: Yes, and obviously you can’t go and change these indices every month. There must be good reason to change that. Johan: Yes, otherwise they can manipulate it up and down. Christa-Marie: Yes, and that’s why we start off by using independent indices that cannot be manipulated by either Sasol or the supplier. Johan: What will you say, what’s the biggest mistake people make in determining that independent index? Christa-Marie: I think don’t go for average PPI. Many companies do that. Johan: The PPI… Christa-Marie: The average PPI. Because we call it the PPI All Groups. It’s the average of the average of the average. Rather try and find as closely-related index as you can get. It can give you a total different picture at the end instead of using the PPI overall index. That’s another thing that we must just
114 remember, we’re working with averages, the industry averages and we need to be better than the average to get the benefit.
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APPENDIX E TRANSCRIPT OF INTERVIEW WITH MR NAAS DU PREEZ
Mr Naas du Preez interview transcription Interview held on 21 May 2010, Sasol Head Office, Johannesburg
Johan: What was the reason for starting with strategic sourcing in Sasol? Naas: At that stage I was Commercial Manager: Optimisation and it really started off with Nereus. What triggered it was obviously cost savings because of economic pressures and I think a company like Sasol must always look at reducing cost. But reducing costs, even from a supply chain point of view and I must state at this stage I don’t think we were aware of the total cost of ownership concept. So at the very first, early stage we just said okay, let’s look at where we can reduce cost, save money from a supply chain point of view. Johan: Can you explain to me then the process that you have followed at that point to establish the potential? Naas: Maybe I should go back. Initially when we said let’s see whether there are opportunities, obviously we looked at the total spend of Sasol and of the different divisions and we didn’t at that early stage go into identifying commodities or commodity groups. That was just the bulk spend as far as I can remember. And then we went out on a RFQ to several consultant groups to say what can you put on the table, and it was really not, you know not the biggest detail in terms of what we expect. But we said what can you come up with in terms of savings and cost reductions? We had discussions with all of them and the feedback was quite interesting. I can still remember the figures that were mentioned by most of them at that stage was R30 million to R50 million and eventually when McKinsey came in, they spoke about R400 million to R800 million. We had long discussions with them and then we started realising, but we’re talking total cost of ownership, which is far from saving money on procurement or what you pay for stuff. We also then realised that they did work at Iscor at that stage, which is now Mittal. And we got representatives from Iscor to come and give us a presentation of their expectation, experience because they had been down that route for quite a
116 while then. And I think that made a major difference in our understanding, also then contributed to the decision to go for the McKinsey’s total cost of ownership and strategic sourcing way. Johan: How did you get internal buy-in for the process? Naas: Initially we had discussions and it was mainly Nereus and I that started off the discussion with McKinsey at that stage. And obviously they then prepared their presentations that actually reflected how they go to work. We then went to the Exco. We had a lot of discussions, one-on-one discussions initially, even up to Peter Cox at that stage, and that took quite a while. We had to work through single individual sessions and then eventually we made a presentation to the Exco and eventually the concept was accepted and it was decided to go ahead. Now you come with a project plan on how you’re going to roll out. Johan: Naas, now what was the original view of the key stakeholders on the possibility of saving R400 million? Naas: I think they were sceptical initially because at that stage the MDs or the GMs still did not understand it, but decided to go for it. It seemed almost impossible, but once we started understanding that you’re looking across functions and that you’re looking at total cost of ownership from a supply chain end user or stakeholder point of view, it became clear that it is possible. So, initially there was, I won’t say resistance, but there was a lot of convincing to be done that it can be done. Johan: So you say it took a while to convince everybody? Naas: Once we had the go-ahead, we actually had to visit each and every head of a business unit at that stage as well as his reportees and again discuss this plan, sorry, explain how we’re going to do it and there was a lot of discussion. I mean it really took a lot of travelling, a lot of time talking to, on the business unit level also with their management structure. And then of course the implication also became clearer because you need people to run this, to run the whole process. And the decision (and I think that was an excellent decision) was taken that we will, each business unit will somehow give people to this process to be part of the value teams or the money teams as they initially were known. But we’ve changed that name because the connotations were not that great.
117 This is a totally different kind of thinking in terms of saving or cost reduction and we will need our people and will need a mixture of people. Johan: Then what were the main issues that you were confronted with when you had worked with the business units and tried to get buy-in for the process? Naas: The one thing that makes or breaks a process like this is whether you’ve got top management support because that is absolutely crucial. If you haven’t got that support, you can forget about it. I think the other point going with that is how do you use or apply that support? Do you use it in a threatening way or do you use it to support your arguments? So the main issues I would really say are to understand the concept of a cross-functional approach to be able to put money in the bank. That was maybe one of the biggest issues to get around and then obviously initially it was quite a problem to convince people that we need people out of the organisation that will be part these value teams, and we started off with fourteen to sixteen weeks. These people would be out of their work, out of their position for that period on a full-time basis. That took a lot of convincing but eventually I must say the people just worked together. So the first value teams we really had to go out and search and I can’t say beg, but let’s say beg. But once we had this traction and we saw there were results, it became easier to get people for that, for the value teams. Johan, What was the process that you followed to determine which commodities to start with? Naas: Well what we did is, and that was the McKinsey contribution, is to interrogate all the spend from all the business units and see where we spend the most money. The typical 80/20 principle: which commodities and where the money went and from that we made a list of about 80 to 100 commodities. That really was where the most money was spent. And then those commodities were actually put into commodity groups. For instance, let’s talk about transport or chemical, processed chemicals. And there were presentations to a steering committee, I should have said that before, that was set up under leadership of Nereus and we had to come and present our case to say these are the commodities and we propose to do this with X, Y and Z. So I think the very first round we started off with seven value teams, if I can remember correctly. But it had to do with the strategic, high-value commodities and what are the TCO potential of these commodities. So those were two of the driving forces to determine what we are going to do, and prioritise these commodities.
118 Johan, How important was measurement? Naas: Measurement, let me just say what happened at that stage; everybody knew we had to measure and there I refer to tracking. When we started we had to verify and prove and put in place how much we’ve actually reduced cost. So initially we had a small team that started looking at how we track what we put on the table. But the further we went it became clear that it is absolutely vital. There’s not even a way that you can think to do this project without measuring the successes or then the failures for that measure. There was actually a team created to set up a tracking system. On it’s own this was quite a challenge because we had to decide and eventually you’ll have to come with a policy to say how do we define cost reduction, a TCO cost reduction and a saving. Everybody had to know how to actually report it. It wasn’t just, you know, slap-dash. You can’t do without it otherwise you cannot even prove that the project has delivered what was supposed to be delivered. Johan: So what you’re saying to me is, as soon as you were allowed to proceed with this new approach, you had to continuously prove the value that’s released and basically your value proposition? Naas: Oh yes. Well I think it’s really slightly even more than that. Obviously this was a growing process, an evolving process. But looking back and having been exposed to other processes, similar processes and if you can see it up front, you need your targets and those targets must be set up front as soon as possible for value teams, for commodity groups and you must track on a regular basis end we did it on a monthly basis, on what was your target, what was your projection and where are you now? And if you’re not on target, why not and what are you going to do to get there? So it becomes almost a non-negotiable once you’ve pegged down your targets. Then you must live up to it and therefore we had a monthly feedback per team, and eventually when the commodity teams were put in place, which was later, they had to report back on a regular basis. Where were they, compared to the targets, what are they doing, how are they going to make it up? Johan: The results at the end, what was the highest level at which this was reported? Naas: The Group executive committee
119 Johan: Measuring total cost of ownership, it’s not so easy? Naas: Yes. Johan: Can you explain to me some of the tools that you have put in place to measure this? Naas: I know specifically that we started at that stage the tracking tool. And every team had access to the tracking tool and the targets were in there and they had to update it on a regular basis, which was monthly. Johan: So my question now is: after you’ve left Sasol, you’ve worked with many companies as a consultant in the area of strategic sourcing. Will you say that the principles and the things that were developed in Sasol are still world-class today? Naas: I still think it is definitely world-class. I’ve seen this now operating in two to three other companies, the whole process. And I think that the major strength is that we realised that we have to go crossfunctional from day one and that we’ve applied and that is working for us. It will be different the second time, because you’ve got hindsight, and you will maybe start a few thing earlier. For instance your tracking system, to get that going as soon as possible. Yet, I also think you have to understand, you have to explore what is in your company, in your business in terms of commodities to be able to put together a tracking tool. You can’t just buy a tracking tool off the shelf. I think it needs to be customised for that process and for the business unit. But in terms of the process, the way we did it, I think it worked very well and I can recommend it. Johan: In your opinion, what is the main things that need to be in place before a company can embark on strategic sourcing? Naas: I want to almost use the word a burning platform. But if there’s a burning platform it comes much more naturally because everybody really wants to understand why you do it and why we do it. So that’s the one thing.
120 Johan: Anything else you would like to add in general? Naas: I think when we started, this whole concept wasn’t that prevalent and I don’t think we knew a lot of. If ever you want to go into something like this now, talk to other companies that have done it, because it has a massive influence on the company itself in terms of the culture, the way you think, the way you do things, obviously on the structure because you are working across borders now. And I mean it’s a physical structure, but also I want to call it a thinking structure. You cannot only think in your own box anymore. As long as you think, you must think company-wide and hopefully globally-wide if you can. So it brings along a massive change to a company if it’s done correctly and I don’t think it’s something that you build in a week or a month or even a year. It takes time, it take a few years to really make it work.
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APPENDIX F TRANSCRIPT OF INTERVIEW WITH MR WIKUS KRITZINGER
Mr. J.L. Kritzinger interview transcription Interview held on 28 June 2010, Sasol Head Office, Johannesburg
Johan: When Sasol made the decision to embark on a process of strategic sourcing, what will you say is the key learnings for Sasol if you look back today? Wikus: Johan, I would say you know we started with strategic sourcing, let’s say, about ten years ago and at that time there was of course a bit of market pressure. We realised that sourcing was at least one of the very important key strategic levers that we can pull to unlock a lot of value and we were very fragmented at the time as far as sourcing is concerned. And at that time we were very much on a basis of almost three-quotes-and-a-buy. You know there was no strategic impetus as far as sourcing was concerned and we appointed a consultant, McKinsey at the time, to bring the concept of strategic sourcing to Sasol and I think the one thing that we have to realise is that, especially with a consultant like McKinsey, you have a guy who brings a lot of strategic thinking into the company. But that’s still got to be made to work. You have to still make this whole strategic concept work. And I think a lot of things, you know if you are thinking about this fragmented approach, you need to get people to work across business units and then that is a big challenge in itself in any company, but specifically Sasol at that time. Even today we’re still very fragmented and to get people to work together is quite a challenge. So first and foremost, it was quite an investment to get McKinsey on board, but then after that you also have to bring people up to speed. You have to actually work across boundaries. You have to invest in a lot of systems because all the stuff that you are doing must be measured. You must invest in people to bring them into a culture of working across boundaries. So if you look at only the investment in your consultant, that’s only a very small portion of investment. The big portion of the investment of course is in the systems and the people and time going forward. And the other thing is, of course, that you should not see this as a project. I think we had a lot of companies which knocked on our doors afterwards which did the same thing, that they saw it as a project and they unlocked a lot of value as we did, right initially but they stopped it at a certain point in time and they just lost the momentum. And all the things and the good thing that they did were lost and we actually sustained that. And that’s where we always in terms of strategic sourcing talk about the sustainable benefit. And there’s effort that goes into sustaining what we have. At this point in time we sustain around
122 about R3.8 billion to R4 billion of benefits and it’s not easy to sustain that. You have to work to sustain that benefit going forward. So it’s not a project. It’s a way of life in the company. Johan: It’s a business process in itself? Wikus: Yes. Johan: Can you recall what was the original amount that you had to pay the consultants and thereafter what did Sasol have to invest in the process? Wikus: In think the original amount to the consultants, of course today it will be a different amount because that was in 2000. That was round about R20 million. And then we spent at least another R100 million in terms of people and systems. Johan: In terms of the Sasol process today of strategic sourcing, what are you good in? Wikus: If you look at the strategic sourcing process you have a sort of tripartite relationship in that you have your supplier, you have your end user and you have your strategic sourcing person. And in that whole thing, I mean the outcome of the strategic sourcing process is of course a sourcing strategy and if you look at the components of a strategic sourcing strategy there’s a lot of stuff that you have to address in that and I can honestly say that we have good strategies as far as all the different commodities are concerned. So if you look at commodity strategy or sourcing strategies for the different commodities, we actually devised good strategies. Part of the strategies of course is the specifications because that comes from the relationship with you end user. You’re in a position to challenge your specification and make sure that we have specifications that support the whole TCO principle. Sometimes you don’t buy the cheapest. I mean you may find that you would like a more expensive commodity to support the TCO and to bring the total cost of ownership down. And that is another thing that we are good at, and then the whole supplier selection process which we refined to such an extent that we can be quite proud. What is however important is that we start to standardise our process which we currently drive through our Functional Excellence process, as well as the issue of 13 ERP systems.
123 Johan: How did the fact that Sasol had implemented strategic sourcing help Sasol in the 2008 global economic crisis? Wikus: We have a very well-known supplier base which we know very well and we have in a lot of cases a strategic relationship with these guys. We have a very detailed spend analysis where we know exactly what we are spending on what. And this gave us the platform to immediately respond and to see to what extent we can lower the baseline of spend over a very short period of time. And that resulted in a year’s time; us lowering our baseline spend with about R 4 billion. Johan: If you read the latest articles, they refer to a balanced scorecard approach for measurement. In terms of procurement, and specifically then strategic sourcing, are you still only sticking to the measurement of the benefits or did you also change that approach? Wikus: The ticket to the dance of strategic sourcing is of course the measurement of the benefits. It will remain a very important part of the measurements. But as far as strategic sourcing is concerned, you have to break that down into all the different DOVs and then you have to agree with all the stakeholders in this strategic sourcing triangle what the DOVs are. The way that we manage this is that it’s been signed off by Steercoms which actually represent all the end users because they are the receivers of the benefit. And then you have to drive and make sure that you achieve you DOVs. Johan, So in a South African context, how big do you believe the Sasol procurement spend is? Wikus: Well you know if you include capital, I mean we are going probably up to a R100 billion per annum in terms of spend and people normally don’t know how much money that it, but that is close to R15 million to R20 million per hour on a 24/7 basis. Now that is a lot of money. I think we will probably be in the top five, if not in the top three in South Africa as far as procurement spend is concerned. Johan, Another thing that’s pointed out in literature is the fact that, when you want to embark on strategic sourcing process, everybody talks about skills and you need new people. What is Sasol’s experience in this regard?
124 Wikus: In terms of people we decided that we would like to do this whole strategic sourcing approach with building our skills in-house so we developed a lot of courses as far as strategic sourcing is concerned, to actually equip our people to learn the skill of strategic sourcing. That is the one thing that we did. Because sourcing is only the other side of the coin from marketing, there’s no sense in having a guy sitting across the table which is a very much lower level as far as sourcing is concerned and you’re pitching against a guy from a supplier which is a very important and high level marketing guy around the table. You have to have these people on par. And so we invested in a lot of development of our own people. We developed with UNISA a curriculum to skill our people up. A lot of people did a degree through UNISA as far as procurement is concerned as one of the majors. And another thing about people, I think, what we should also mention is, that in sourcing I mean, you can have your people highly skilled which we did. But over time people don’t see – they look at the same problem through the same eyes and it’s also beneficial to get your people on rotation basis to get new people looking at the same problem with different eyes. And in doing that, you also release new value from your sourcing activities. Johan: As the general manager for supply chain in Sasol, how do you see the future of procurement and do you see new value being released? Wikus: First and foremost you have to sustain, as we already mentioned, you have to sustain what you have. You shouldn’t see this as a project. So you have to sustain your R3.8 billion that you have. But of course, as I mentioned, look at the same problem with new eyes. And it’s actually quite amazing that every time that you look at your current and existing commodities you release new value and all these things are audited. It’s not pie in the sky type of stuff, so it’s really well-defined benefits that we extract by the sourcing process. So we would like to build further on that. But as we progress and people get more used to the concept of strategic sourcing and also you actually build the creditworthiness of strategic sourcing, which of course, if you apply the same principles you will add more value. So the R3.8 billion to my mind is only a start in term of MRO spend. We can add a lot more as far as that’s concerned just by doing a few things. Our target towards 2012 is to add another R2 billion. Making sure that you bring more spend into the ambit of strategic sourcing by having your people trained well and making sure that they have all the skills. Rotate the people that you look at the same problem with different eyes and that will also release a lot of value. In the end, of course the whole question of capital. And as we all know, TCO, the TCO principle also applies to the capital environment and if you bring capital which we did not do up to now, and that is in the vicinity of R20 billion per annum, into the same ambit as far as strategic sourcing in concerned, there’s a lot more value to be unlocked.
125 Johan: How do you view ethical behaviour within procurement and supply chain? Wikus: Well ethical behaviour as we all know, as far as procurement is concerned, that is probably the one area as far as corporate governance is concerned, where about 70 per cent of all fraud takes place in the ambit of procurement. So I think it’s of utmost importance and non-negotiable to have people with high ethical values to do whatever you need to do in the procurement space. And I’m not talking only about strategic sourcing. Of course strategic sourcing is a very important part of it. But the whole procurement ambit contracting and everything else that goes with procurement, I think ethical values are of the utmost importance. And as you also know, that is also one of the values of Sasol. We have a few values that we look at in the procurement space. It’s actually the problems that we had with competition law and I think we really focus at this point in time throughout the Group, but especially in the procurement environment on training our people in terms of competition law issues, but also in terms of other laws applicable in the procurement space.
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