Pursuing purchasing excellence in chemicals
While
chemical companies recognize the importance of strong purchasing capabilities,
few have transformed the function into a source of strategic advantage. Here’s
how they can.
Obtaining raw materials at the right price, specification, quantity, and
quality is fundamental to the profitability of chemical companies. Purchasing
expenditures are equivalent to 20 to 60 percent of sales revenue for
specialty-chemical players and 50 to 80 percent of revenue for makers of
commodity products. It isn’t just the size of purchasing spending that makes it
so significant for chemical companies. The return of severe raw-material
pricing volatility—with oil prices down by over 50 percent from two years ago—means
that making the right purchasing decisions matters more than ever.
An increasingly global market for raw
materials has developed since 2000, giving chemical companies a broader choice
of price and grade for many commodities, albeit with important implications for
lead times and transportation costs. This supply continues to evolve, with new
resources such as output based on low-priced US shale gas coming to market.
On the demand side, many companies face
increasing complexity as their customers request niche products to suit
particular end uses or to meet diverse local regulations—and this affects what
they need to buy. In addition, players must find ways to profitably operate
their asset-heavy and inflexible production systems.
A purchasing-improvement initiative can
make a substantial contribution to better financial performance. Reducing
overall spending by 6 to 10 percent (a reasonable goal if spending is 50
percent of sales, based on our observations in the sector) can deliver a boost
of three to five percentage points in earnings before interest and taxes
(EBIT).
Good
but not yet great
With so much value on the table, it is no
surprise that the chemical industry has developed stronger purchasing
capabilities in recent years. But there is room for further improvement. In our
global purchasing-excellence benchmark, for example, the chemical industry
scores an overall average of 2.6, putting it in the top half of industries in
the study.
Perhaps more telling than the average
performance figure, however, is the spread. While 85 percent of the chemical
companies studied demonstrate solid middle-of-the-pack performance, only 6
percent of them appear in the ranks of true purchasing leaders for the overall
sample. This suggests that fewer than one in ten chemical firms have taken the
next step in purchasing performance: turning their purchasing functions into a
source of sustainable competitive advantage.
Chemical
complexities
There are sound reasons why fewer
companies in the chemical sector have achieved purchasing excellence compared
with those in the automotive, high-tech, and consumer-packaged-goods
industries. While there are common approaches to optimize indirect spending in
most industries, direct spending in chemicals presents two particular challenges.
First, the products are complex. For a
commodity-chemical player, 10 or 20 products may account for half its overall
spending. That might seem like a straightforward buying proposition, but this
is deceptive. Each product may be available from multiple locations and be
supplied in several basic forms and numerous grades. In addition, relatively
small changes in the characteristics of these inputs can lead to big shifts in
the cost of processing them into finished products. That makes chemicals a tough
environment to make optimal purchasing decisions in, and it requires purchasers
to have deep knowledge of the technical and supply-market intricacies of their
categories. Despite this complexity, the pricing of many chemical commodities
is largely driven by indexes, making procurement appear simpler than it really
is and discouraging companies from investing in the expertise they need.
Second, there is the long tail of
lower-volume products. Chemical players, particularly in specialties, may use
thousands of additives to fine-tune the characteristics of their products to
suit customer needs. Some additives may be used rarely or in tiny amounts, but
they can be fundamental to the performance of the end product. Similarly,
companies may have to supply products in hundreds of different combinations of
packaging and labeling. Even when achieving better purchasing value in these
categories is straightforward (and often it is not), to do so can present a
formidable workload for purchasing teams.
Because of these complexities, companies
tend to limit their purchasing-improvement efforts. These efforts typically
include classic procurement levers, such as bundling products with fewer
suppliers to capture economies of scale and negotiating aggressively to push
prices down.
The
road to excellence
The most successful chemical companies,
regardless of size, sector, or geography, take a different tack. First, they
segment purchasing categories according to value and strategic importance.
Second, they use a comprehensive approach to purchasing optimization that goes
far beyond the traditional levers just mentioned.
Chemical companies that get this right can
capture substantial gains. Our data on more than 500 chemical-industry
commodities show typical savings from adopting best practices in procurement
that range from 1 to 5 percent for base commodities to 10 to 20 percent for
fine and specialty chemicals. In indirect categories, the savings potential can
be even higher—as much as 30 percent in facilities management, IT and
telecommunications, or office supplies, for example.
Segmenting
by category
Purchasing excellence starts with a
thorough segmentation exercise to identify the products that are strategic and
critical to the company’s operations .
In most cases, strategic materials
comprise a small number of commodities that represent a large part of the
company’s annual spending. Critical materials are products on which it spends
less, but are critical by nature of their importance to the company’s end
products and the risk of supply disruptions or price volatility. For example, a
limited supplier base may present possible availability issues.
Companies can then adopt a different
approach for the tail. This comprises the remaining products that are lower
volume and less important; the supply of these is often best dealt with by
being handed off to distributors.
Taking
a comprehensive approach
For strategic and critical materials,
best-in-class companies deploy a comprehensive approach to purchasing
optimization that includes three elements.
Commercial
levers
Most chemical companies use contract and
supplier management as their main lever when buying important direct materials.
Best-in-class companies bring some additional elements to the mix. They are
rigorous about renegotiating supply agreements when major changes occur, such
as recent oil-price declines, and they are careful to define contract terms
that control price-volatility risk.
But perhaps most important, they reinforce
their traditional commercial capabilities with a comprehensive and up-to-date
fact base and strong analytical skills, which give them a deep understanding of
suppliers’ true costs and how changes in the market will affect their
purchases. The result is that their negotiating teams rely less on strong-arm
tactics and more on identifying the real opportunities for the supply of
materials at lower overall costs.
Such a fact base starts with an
understanding of the global marketplace of the chemical product in question.
The price of chemicals can vary dramatically from region to region depending on
the quality and availability of raw materials, the price of energy, local
demand, and the production capacity in that area.
This chart also hints at the way relative
cost advantages can change dramatically. Low energy costs may promote a wave of
investment in new capacity in the United States in the next few years, for
example, and scale and technology advantages may help to widen the cost gap.
Understanding the dynamic nature of the cost curve helps companies plan their
purchasing strategies for medium- and long-term advantage, for instance, by
building relationships with suppliers in regions where costs are falling.
Prices can fluctuate predictably over the
short term, too. Sometimes seasonal demand from other industries for a
commodity can push up prices at certain times of the year, creating savings
opportunities for companies that can use more of the material during periods of
low demand.
Changing supply-market dynamics make it
important for companies to understand the way the supply base in key commodity
groups is evolving. New suppliers frequently enter the market, aiming to
capitalize on rising demand in a region or on local production-cost advantages.
Best-in-class companies take a systematic approach to gathering of market
intelligence on current and new market participants. By understanding the
investment plans of these suppliers, as well as the changing conditions in
their major markets, they often can identify new sources of savings.
Even within regions that are well placed
to provide a commodity, differences in suppliers’ scale, technology, plant
utilization, and business strategy can lead to substantial differences in their
costs. Clean-sheet cost models are an effective way for companies to build an understanding
of suppliers’ underlying costs (see sidebar, “Clean-sheet cost models”).
Once companies have identified
opportunities to extract additional value, they need to capture it using a
smart, structured approach to supplier negotiations. Preparation is the key to
success here. Companies should develop a deep understanding not only of the
category itself (often with the help of clean-sheet models) but also of the
commercial relationship between the buyer and potential suppliers. Is the buyer
a strategically important customer for the supplier, in this category or
others? Do the two organizations have a track record of successful
collaboration? Understanding how a potential deal looks through a supplier’s
eyes can help companies pick the right negotiation strategy.
Face-to-face negotiations may still be the
best option in cases where spending is high, suppliers are few, or there are
opportunities to improve value through technical changes. But in other
situations, Internet technologies have increased the range of negotiation
options available to purchasing teams in recent years. Companies may use
electronic request-for-quotation, or eRFQ, systems to get one-time bids for
commodities from a range of suppliers, for example, or may choose e-auction
techniques in which multiple suppliers are encouraged to bid against one
another in real time. For some chemical companies, the latter technique has
proved effective in obtaining price reductions of 30 percent or more from
incumbent suppliers. These techniques are best applied in markets where buyers
have multiple supplier options, as we have observed they can damage long-term
relationships with suppliers.
Technical
levers
The leading companies also find
opportunities to cut costs by focusing on technical levers. In many cases,
changing the specification or grade of purchased products can deliver
substantial savings, although it is essential when making such changes to
understand the implications for total cost of ownership.
A deeper understanding of the production
costs and capabilities of suppliers—often obtained with the help of clean-sheet
models—can help to inform companies’ decisions about the form and specification
in which to obtain their key inputs. Obtaining some inputs in a dry state
instead of as a solution, for example, often will reduce the weight and volume
of the product, reducing transportation costs. If the drying process
significantly boosts energy costs at the supplier, however, or if it creates
extra handling and storage challenges after delivery, the total cost of
ownership of the dry commodity may actually be higher than the bulkier liquid
form.
Similarly, different material grades can
have implications for supplier production costs, transportation, and use.
Caustic soda, for example, can be obtained in solution at a variety of
concentrations. Higher concentrations mean lower volumes, reducing
transportation costs, but they also have a higher freezing point. A 20 percent
caustic-soda solution will remain liquid at –22 degrees Celsius, for example,
while a 60 percent solution must be kept above 50 degrees Celsius. This means
high concentrations may require more costly insulated containers to prevent
freezing during transport.
Chemical companies can adapt some
processes to make use of quite different raw materials. For example, a company
could adapt its production process to switch to whichever source is available
at the lower price, as the food industry does for cane sugar and corn syrup.
Similarly, companies can sometimes optimize product recipes by reducing the
percentage of the most expensive materials in favor of cheaper ones. Such
strategies need careful analysis, however, as the characteristics of
alternative inputs may require compensatory changes to other inputs or to
process parameters. But for companies that master these complexities, the
benefits can be significant. Some chemical players have even adopted a dynamic
approach to material substitution, for example, continually modifying the ratio
of certain inputs in response to price changes.
The choice of packaging and transport can
make a big difference to logistics and supply-chain costs. For example, liquid
products can be supplied in a wide range of containers, including flexible
plastic bags, drums and bulk containers, or even road tankers, rail, and ships.
As the volume of these containers rises, the relative cost of transportation
drops, but the need for specialized equipment to unload, store, and handle the
product on arrival also tends to increase. Buying in large quantities also has
implications for inventory size and flexibility.
Finally, collaboration with suppliers can
create value in a number of ways. One chemical company found that a supplier
had the capacity to conduct an extra process step at its own plant before
delivery. This change in the supply chain helped to relieve an important
capacity constraint at the customer’s plant. Other companies have worked with
their suppliers to help them remove bottlenecks and implement cheaper, faster,
or higher-quality production processes, and they shared the benefits.
Demand
levers
The third set of levers that best-in-class
companies use concerns their own production processes. Better coordination
among sites or business units can often reveal significant opportunities for
savings. For example, standardizing the specifications of finished-goods
packaging at different sites can reduce the overall number and variety of
containers purchased. Similarly, moving from local to central inventories of
certain inputs can reduce requirements, if sites are located close enough to
make this a practical option.
Harmonizing the specifications for a
commodity can sometimes reduce costs with little or no impact on the process or
end product. One company found that different business units ordered a key raw
material from two suppliers with different concentration tolerances. When the
company analyzed the materials it received, however, it found not only that the
cheaper material was suitable for most of its processes but also that samples
of the material actually exceeded the tighter specifications.
The most significant way to shape demand
can be deciding not to purchase a particular material at all. Alternative
manufacturing technologies can accommodate different inputs, for instance, and
potentially allow an organization to substitute a lower-cost ingredient for a
higher-cost one. Such changes may require investments in new equipment,
however; any such substitution decisions will require careful consideration of
the total cost of the change and of the likely evolution of the different input
costs.
As with the deployment of technical
levers, effective demand management is by necessity a collaborative process.
Best-in-class companies often find it useful to run workshops involving
technical and manufacturing staff from all affected business units, together
with colleagues from purchasing and representatives from suppliers. In these
workshops, cost-saving ideas are identified and evaluated, and then the most
promising ideas are taken forward to be tested and rolled out across the
organization.
Tackling
the tail
Analyses like those described above are a
powerful way to deliver cost savings for the most important products in a
company’s purchasing portfolio. But the depth of knowledge and complexity of
analysis required makes a similar approach unfeasible for the thousands of
items that make up the tail of a company’s spending (shown in the bottom left
quadrant in Exhibit 2). That does not mean chemical companies can’t achieve
significant savings across these categories: what they need to do is find an
approach that balances management costs with savings opportunities.
For one, companies can buy products from
the same suppliers they use for critical, high-volume materials, aiming to
achieve more favorable prices through the bundling. They can conduct a
request-for-quotation exercise or ask for a discount from existing suppliers.
Alternatively, they can aim to eliminate the requirement for the material
altogether by substituting something else for it or stopping its manufacture,
for instance, when the end product is a niche offering with little commercial
value.
Another valuable approach involves the use
of third-party distributors. By bundling multiple categories with a few
carefully selected distributors, companies can secure volume agreements across
categories and reduce the number of small suppliers they need to manage
in-house. The distributors themselves, meanwhile, can often obtain favorable
terms with manufacturers thanks to the higher volumes they purchase for multiple
companies. Distributors may also be able to identify more cost-effective
sources for tail-spending categories, for example, by researching and
qualifying new suppliers in low-cost regions.
Distributors must still be managed with
care, however, to ensure they do not add excessive charges for services such as
repackaging bulk materials in smaller containers. Once again, chemical
companies can use clean-sheet techniques or analysis of different suppliers to
identify “should” costs for such services and compare these with terms offered
by their distributor partners.
Companies that have taken a systematic
approach to tackling their tail spending typically find they can achieve
overall savings of 10 to 15 percent through a combination of bundling higher volumes
with suppliers and negotiating improved terms with those companies. Such
savings can often be captured quickly, with the entire analysis, segmentation,
and renegotiation process taking as little as three to six months.
Managing
purchasing performance
To underpin all the purchasing levers
described in this article, chemical companies need a strong management
approach, with clear and regular tracking of the savings achieved. Tracking
savings is vital for chief purchasing officers because it lets them see how
different parts of the purchasing organization are performing. But it is also
important for the wider organization because it demonstrates the impact of
advanced purchasing approaches and helps best practices to gain wider adoption.
Measuring and tracking performance is not
always straightforward, however, particularly for categories where the purchase
price is index driven or dependent on underlying oil or energy costs. To avoid
purchasing teams being rewarded—or punished—for changes outside their control,
leading companies track savings by measuring the discount obtained against the
appropriate index. They then record year-on-year increases in that discount as
savings achieved through improved purchasing performance.
For many chemical companies, purchasing
excellence demands a significant change in technical capabilities, processes,
and mind-set. That doesn’t happen overnight. The best companies look at
purchasing transformations as a journey, in which each step builds on the
foundations of their current strengths and provides a platform for further
improvements. With commitment, top-management support, and a strong plan in
place, we’ve seen chemical companies complete that journey in two to three
years. In doing so, they have been able to achieve overall spending reductions
of 6 to 10 percent while simultaneously improving supply security and reducing
their exposure to volatile commodity prices.
-
Raffaele Carpi is a partner in
McKinsey’s Lisbon office, Marco Moder is an associate
principal in the Frankfurt office, Frank Plasschaert is a
senior partner in the Antwerp office, and Marco Ziegler is a
senior partner in the Zurich office.
FOR EXHIBITS SEE http://www.mckinsey.com/industries/chemicals/our-insights/pursuing-purchasing-excellence-in-chemicals?cid=other-eml-alt-mip-mck-oth-1606
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