Thursday, October 16, 2008

The promise of purchasing software

The promise of purchasing software

New software can provide procurement managers with more information about their operations but can’t overcome flawed processes.

November 2003

There’s no secret to good purchasing: find out what you are buying, centralize procurement, and reduce the number of suppliers and of the different items you buy. Why then are so many companies unhappy with their efforts to improve the process?

According to many purchasing managers, the problem is that they don’t have the information they need to make appropriate changes. Thanks to enterprise-resource-planning (ERP) software, financial managers can track flows of money from one end of a company to the other. By contrast, purchasing executives historically haven’t been able to see who is buying what from whom. In recent years, however, a number of software vendors have begun to offer products that help get at the hard-to-reach corners of purchasing.

To study these issues, we not only examined the vendors and their software but also spoke to users.1 While few if any new technologies can ever provide a quick fix, this type of software, when paired with the right business changes, does help companies to understand their total purchasing outlays and to save money.

Two areas of purchasing have proved particularly resistant to improvement: spending analysis (getting a handle on everything a company purchases) and demand management (questioning and controlling whether the company needs these things anyway). Managers at fully 95 percent of the companies where we conducted interviews pinpointed tasks within these two areas as high on the list of things with which they sorely need assistance (Exhibit 1).

Chart: Stubborn problems in purchasing

At present, many companies don’t have a clear process to manage demand even for frequent purchases, such as personal computers; one department might get them from an IT vendor while another buys them off-the-shelf at Wal-Mart. Despite the fact that a company-wide program could bring volume and service advantages, managers are free to approve these purchases as long as the costs don’t broach departmental budgets.

Although the new purchasing tools vary in complexity, they have in common the ability to bring information together to provide the whole purchasing picture. Companies running ERP software have come close to this goal, but ERP is tailored to financial accounting and control, not to purchasing. General ledgers track spending by cost center; invoicing systems track how much each vendor was paid. To provide the whole picture on spending, purchasing-management software must consolidate general-ledger and invoicing systems.

McKinsey research suggests that the new tools show promise for both demand management and spending analysis (Exhibit 2), though neither can be fully automated in most instances. The linkage of general-ledger and invoicing systems to analyze purchasing data, for example, is most valuable when combined with efforts to clean up a company’s (often sloppily maintained) databases on vendors. The new crop of analytical tools can automate such efforts enough to make the databases more valuable, but to complete the job human eyes must still correct the computer output.

Chart: A helping hand

Likewise, though demand-management tools can automate processes and policies already in place (guiding requests for new PCs to preferred vendors, for example), they can’t devise new ones. Purchasing managers must still do that, basing their judgments on a holistic view of procurement—a view the new software might help them develop. For instance, they need to assign ownership of spending on any particular product to the group that knows the most about it and to help that group share the responsibility with all other parties using it. Managers should link savings targets in each category of expenditure to departmental budgets, track the savings, and tie the bottom line to individual performance evaluations. All of these practices, our respondents say, ensure that companies can sustain the savings made in purchasing.

Combining the new software with sound principles can help get companies closer to the promised land of purchasing, particularly when they use tightly integrated tools. An electronics company we studied defined the components of its spending, identified the data sources required to track products through their life cycle, automated its invoices, and defined a simple data model to link general-ledger and invoice data. The company improved its compliance with demand-management policies to above 90 percent, from just above 70 percent. Yet using the new tools without changing business practices can have the opposite effect. A medical-device company, for instance, deployed the software to automate its purchasing approvals before it developed a complete view of total spending. The result, as the company’s chief financial officer told us, was that "We used to take two weeks to buy a lot of the wrong material, and now we still buy a lot of the wrong material but do it in a day."

Finally, our research found, for a company that bases its purchasing on good principles, the more procurement it manages to push through its automated tools, the more it saves—not a counterintuitive finding but a rewarding one. Our sample companies, on average, crossed a threshold when they used the software for around 13 percent of their expenditures, at which point its value became apparent. Moreover, we found that tightly integrated spending-analysis and demand-management software tools—obtained either through applications suites or through a company’s own integration efforts—provided superior results by ensuring accurate and complete flows of information between applications.

About the Authors

Kishore Kanakamedala is a consultant and Glenn Ramsdell and Paul Roche are principals in McKinsey’s Silicon Valley office.


1Our research included interviews with purchasing, finance, IT, and business-unit managers at more than 40 companies as well as an analysis of their quantitative purchasing data. We also drew on our experience helping clients with purchasing and IT issues.