Advanced Analytics, Commodities
Management, and Tracking and
Communicating the Value of
Supply Management
An Executive Summary of the
A.T. Kearney Chief Procurement Officer
Strategy Session
January 27, 2011
Pittsburgh, Pennsylvania
Contents
Alcoa Case Study: Applying Advanced Analytics
to Supply Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
John Foody, Global Indirect Commodity Management, Alcoa
Del Monte Foods Case Study: Commodity Risk Management . . . . . . . . . . . . . . 3
Dave McLain, Vice President and Chief Procurement Officer, Del Monte Foods
Tracking and Communicating the Value of Supply Management:
ROSMA©, the Next Generation of Procurement
Performance Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Carrie Ericson, Vice President, A.T. Kearney Procurement and Analytic Solutions,
and Mark Clouse, Partner, A.T. Kearney
Navigating Beyond the Point of No Return:
2011 Global Commodity and Economic Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Erik R. Peterson, Managing Director, Global Business Policy Council, A.T. Kearney
Introduction
A.T. Kearney’s Sixth Chief Procurement Officer Strategy Session focused on advanced
analytics, commodities management and the value of supply management. First,
John Foody of Alcoa discussed how Alcoa’s procurement team applied advanced
analytics to reduce costs in the wake of the economic downturn. Next, Dave
McClain from Del Monte Foods spoke about his company’s efforts to mitigate
commodity risks. Carrie Ericson and Mark Clouse of A.T. Kearney followed with
a presentation about ROSMA©, a new metric and framework that is being developed
to help procurement and corporate leaders compare and improve performance
over time. Lastly, Erik Peterson, managing director of A.T. Kearney’s Global
Business Policy Council, discussed the five meta-forces that are expected to create
significant volatility in coming years in commodities.
Alcoa Case Study: Applying Advanced Analytics
to Supply Management
John Foody
Global Director, Indirect Commodity Management, Alcoa
Alcoa, a $21 billion world leader in the production
and management of primary aluminum, fabricated
aluminum and alumina combined, is also the
world’s largest miner of bauxite, a main source
of aluminum, sold to a range of industries. For
example, in aerospace, Alcoa provides everything
from the skin sheet used to cover the aircraft to the
fasteners that hold the planes together.
The 2008 global economic downturn was
a challenge for Alcoa’s procurement team as
business units sought the team’s help in reducing
costs. Having completed a transformation that
centralized the procurement organization, procurement was able to help reduce costs and deliver
powerful bottom-line benefits—an accomplishment acknowledged in Alcoa’s recent quarterly
financial releases.
With so many locations, facilities management represents hundreds of millions of dollars
of spend that had not been strategically addressed.
Facility management services can be bundled and
outsourced to external providers. Alcoa buckets
these services into three categories: soft (such
as landscaping, janitorial services and security),
hard (such as mechanical, electrical and heating
and cooling services) and core (maintenance on
production equipment). For core services, the
company traditionally relies on specialized
employees because of the complexity of the work,
although procurement is challenging this strategy.
Facilities management providers run the
gamut—from highly specialized providers of
a single service to bundled providers to integrated
facility management (IFM) companies that can
provide virtually any service in a range of geographies. Alcoa’s ideal situation is to work with IFM
companies, approaching service from a global perspective to consolidate and leverage combined
spend. Many companies already do this, especially
in soft services — though not without a good deal
of internal salesmanship and a strong business
case around the potential savings, as management
at many facilities resists this sort of change.
A host of factors in the IFM market increased
the need for a more advanced sourcing approach.
Externally, supplier capabilities, cost components
and pricing models are key. Cost dynamics must
be understood, especially by weighing specific
supplier capabilities against their costs to determine
the explicit value each offers. Supply-base cost
details must be understood, including should-cost
analyses. Internal factors to consider include service
and location mix, alternative specifications and
the size and diversity of the stakeholders to align
behind any potential supplier switch. Alternative
specifications allow suppliers to “value-engineer”
a standard statement of work by identifying more
efficient ways of performing tasks. The ability
to negotiate with internal stakeholders can be as
important as negotiating with suppliers.
Faced with a dizzying array of service areas,
facilities and potential service providers, Alcoa
turned to collaborative optimization (CO) to
deliver breakthrough results on complex business
problems. CO combines collaborative data collection, which allows creative input to specified
requirements, with business objective optimization, an advanced analysis tool for evaluating
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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across complex, interdependent proposals.
Suppliers engage in expressive bidding, which
allows them to submit unique offers that leverage
their own value drivers.
Technology drives the CO process, starting
with a configurable bid-data template that suppliers
complete with creative, expressive proposals, coupled with traditional bid information. An optimizer, scenario builder and real-time report engine
are also employed to “solve” the equation
by determining which proposals best meet
the sourcing company’s needs. People with
strong analytical talents and skilled data
crunchers are key to the process.
The use of expressive bidding allows
suppliers to submit offers that play to
their unique traits, including their labor
utilization practices, cost management
and scheduling abilities. Among the facets
they “express” are their service capabilities, delivery models, discounts for alternate service specifications and discounts
for “volume bundles” of multiple services
across multiple locations. Essentially, each
potential Alcoa service provider shows
how it can do things better to create advantages
and shared savings. Key quantitative factors
include pricing along with potential key performance indicators that are ultimately required
to drive service level agreements. Some supply
markets, such as logistics service providers that
regularly propose options around potential lanes
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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and transportation networks, already regularly
work in this way.
Geographic coverage was part of Alcoa’s
collaborative optimization process for IFM. As scenarios were defined, tradeoffs among constraints
were considered, such as contracting by region,
within multiple regions or globally. Management
costs were factored in for the various scenarios,
based around supplier count and location.
Alcoa’s ideal situation is to
work with integrated facilities
management (IFM) companies,
approaching service from a
global perspective to consolidate
and leverage combined spend.
Among the critical success factors are data
analytics rigor, stakeholder engagement and supplier management. Alcoa is continuing to challenge
its sourcing teams to use collaborative optimization in indirect spend areas, including temporary
labor, raw materials, value chain sourcing and
telecommunications.
A.T. Kearney
Del Monte Foods Case Study:
Commodity Risk Management
Dave McLain
Vice President and Chief Procurement Officer, Del Monte Foods
About Del Monte Foods
Del Monte Foods is one of the country’s largest
and most well-known producers, distributors and
marketers of premium quality, branded pet and
food products for the U.S. retail market, generating approximately $3.7 billion in net sales in
fiscal 2010.
With a powerful portfolio of brands, Del
Monte products are found in eight out of ten
U.S. households. Pet food and snacks brands
include Meow Mix®, Kibbles ’n Bits®, MilkBone®, 9Lives®, Milo’s Kitchen™, Pup-Peroni®,
Gravy Train®, Nature’s Recipe®, Canine CarryOuts® and other brand names. Food product
brands include Del Monte®, Contadina®, S&W®,
and College Inn®. The company also produces
and distributes private label pet products and
food products.
Overview
Over the past several years, commodity markets
have surged well above previously documented
averages. This increased volatility has fractured
historical correlations and highlighted the lack
of a proven method for predicting prices. As many
companies use energy, grains, dairy products,
meats, sweeteners, resins and metals for their
finished goods, fluctuations in their costs have
severe implications. Margin compression, budgeting decisions and balancing pricing with elasticity
may not only affect earnings but could (if not
properly managed) cause a total collapse.
Numerous factors have a ripple effect on
commodities — weather, increased global demand,
speculative investments, terrorism, the value
of the dollar and energy policies — making the
task of managing and mitigating risk increasingly
difficult.
Methodical approach
In response, Del Monte has moved to real-time
reporting on its market positions and turned to
statistical modeling to optimize hedging scenarios,
calculate risk exposure and better define buying
strategies. These enhancements have also enabled
procurement to prioritize the areas of greatest
volatility in their portfolio using sensitivity analysis.
This has helped identify the commodities in their
portfolio with the largest risk potential so that
price-locking methods can be designed.
Because the users of these commodities are in
a perpetual short position, meaning there is a need
to buy commodities for production, the liability
of doing so in the future is higher because there
is no guarantee of an adequate return. Some trades
later prove to be advantageous while others result
in payments well above the market prices.
To level the playing field, Del Monte has
taken a more methodical approach, starting with
understanding the requirements horizon and
confidence interval. The requirements horizon
is the length of time for which an organization is
confident about its future requirements, or short
position. For some companies, this can be as little
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as 30 days, and their entire sales model could
drop off in very little time. For others, brand
identity and a continuous demand generation
process can ensure 12 months of future requirements with very strong confidence. It is important that the confidence in requirements is measured and monitored to make sure a company is
not locking out risk that may not exist.
Next, Del Monte used internal and external
experts to undertake an in-depth analysis of the
markets. With this analysis, the organization
quantified the benefits and potential exposure
related to each market. With this knowledge,
buying strategies can be tailored to each commodity. These strategies continue to evolve and be
refined as market conditions change and calculated probabilities are taken that lock out risk.
Variance-at-risk
The more progressive statistical approach to
quantifying market exposure (variance-at-risk)
involved Monte Carlo analyses to simulate multiple future scenarios and determine potential cost
volatility for a portfolio of spend. To minimize
the impact of price volatility, procurement
strategies emphasized locking in prices that
increase the probability of achieving targets. In
some cases, this required paying a premium
on current prices. Methods of locking out risk
include hedges, such as options or futures,
or more simply moving from direct to indirect
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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sourcing with suppliers that can manage the
volatility for a commodity.
Identifying correlations and using subjective
forecasting on items that are not exchange-traded
was also vital in establishing the full range of risk in
the organization’s cost structure. With this approach,
Del Monte gained a complete view of potential
commodity risks as defined within a probabilistic
range of confidence intervals. Overall risk tolerance was defined, and the organization modeled
the risk-reduction implications within its portfolio
prior to executing buying strategies.
The procurement organization also performed
a level of should-cost modeling to dissect cost
drivers and develop strategies to manage each
cost component. This provided visibility on the
impact of market movements and alleviated
the impact of having conservative suppliers charge
risk premiums intended to cover uncertainty
in the marketplace.
Because commodity markets are always
changing, this approach enables a structured way
to communicate risk effectively to internal stakeholders. Facts and statistical models helped to
determine future pricing actions and smooth
quarterly earnings.
Top executives accountable to shareholders
welcomed this enhanced visibility of uncertainty,
which has become vital for Del Monte to properly manage its resources and the uncertainty
of commodity risk.
A.T. Kearney
Tracking and Communicating the Value of Supply
Management: ROSMA©, the Next Generation of
Procurement Performance Management
Carrie Ericson
Vice President, A.T. Kearney Procurement and Analytic Solutions
Mark Clouse
Partner, A.T. Kearney
As the procurement function continues to increase
in professionalism and prestige, it faces challenges
in measuring and communicating the total value
it generates. Questions arise around contracted
savings versus realized savings, the drivers of supply
management value, how to generate the best
returns and how performance compares to peers.
To help answer these questions, A.T. Kearney
is developing and refining its Return on Supply
Management Assets (ROSMA©) metric and
framework. The tool translates value created by
supply and the investment required to do so into
a ratio that allows procurement and corporate
leaders to compare and improve performance
over time.
In simple terms, ROSMA divides procurement’s financial results delivered by the total
invested in supply management assets to develop
a ratio that demonstrates the function’s multiplier
effect. Financial results factor in spend coverage,
sourcing velocity, category yields, compliance and
additional benefits, while invested assets include
both structural investments and period costs.
Extensive micro calculations are used to
develop ROSMA’s quantitative score. Its financial
results delivered numerator is influenced by various
drivers. Spend coverage is based around specific
aspects of influence, including sourcing strategy
and collaborations. Velocity refers to the throughput rate of procurement efforts at a company
during a given period, providing a measure of the
caliber of talent, technology and even stakeholder
buy-in to procurement’s abilities. Yields represent
the savings and other financial benefits from procurement’s work using a total-cost approach,
primarily measured year over year. Compliance
measures the degree to which agreements and
policies negotiated by procurement are followed
and enforced, giving finance data that can be used
to hold stakeholders accountable to sourced contracts. Additional benefits are those stemming from
working capital management, payment terms,
inventory terms and supplier risk management—
including the benefits of multiyear contracts. This
provides an incentive to employ long-term deals
without fear that the savings achieved will not
“count” the same way as single-year contract and
annual sourcing efforts do.
In terms of invested supply management
assets, structural investment includes aspects of the
procurement infrastructure such as long-term
technology systems and facility investments. Period
costs include expenditures on people and training.
While the current results lacked some of the
precision that future efforts will possess, data from
A.T. Kearney’s 2008 Assessment of Excellence
in Procurement (AEP) study was used to estimate
ROSMA scores for study participants. The key
finding was that procurement leaders receive
returns of five to six times their procurement
investment, while followers often just break even.
As work begins on the 2011 AEP study,
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A.T. Kearney hypothesizes that scores will likely
vary according to what a company buys—such as
raw materials for a manufacturer versus services
for a professional services firm. For this reason,
the most meaningful ROSMA comparisons will
likely be within industries, where it should prove
to be as relevant a metric as earnings per share.
Procurement leaders receive five
or six times their procurement
investment, while followers often
just break even.
Estimated ROSMA scores based on the 2008
AEP study found that leaders cover much more
spend than followers — 70 percent compared
to 42 percent. Velocity showed a staggering difference, as leaders perform more than three times
as many projects and events as laggards. Velocity
measurement is subject to refinement, potentially
including task-specific weightings to demonstrate
the difference in impact between a seven-step
sourcing effort and a straightforward contract
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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renewal. Leaders also attained category yields
43 percent higher than followers and showed
80 percent compliance to contracts compared
to 68 percent for followers. While these numbers
certainly point to a linkage, the 2011 AEP study
will better demonstrate the correlation between
return on supply management performance
and overall procurement excellence,
especially with the addition of data for
measuring net extended benefits.
Because it centers on a function
that tends to rely on benchmarking
to measure success, procurement and
ROSMA will be a solid match as long as
credible comparisons to other companies
can be made. For example, participants
may need to be segmented in ways
beyond industry, such as by company
size or region. And as is done in other
studies, validation could be performed through
follow-up interviews with study participants.
Industry maturity and company growth strategies will test ROSMA’s credibility somewhat,
as companies in certain situations often exhibit
a typical purchasing behavior. However, because
the Return on Supply Management Assets assessment employs company-specific measures, it may
prove vastly superior to the many benchmarking
tools that rely on averages.
A.T. Kearney
Navigating Beyond the Point of No Return:
2011 Global Commodity and Economic Outlook
Erik R. Peterson
Managing Director, Global Business Policy Council, A.T. Kearney
Five meta-forces — population, resources, the
global economy, technology and geopolitics—are
expected to converge and create significant volatility in terms of commodities and macroeconomic
conditions in coming years. Together, these forces
will generate transformational change at a magnitude that will make us reexamine the operating
assumptions that we currently have in place.
In demographics, a critical inflection point has
arrived. The global population is projected to grow
from the current 7 billion people to 9.2 billion by
2050. Later in the century, however, it will plateau
and ultimately decline. Declines in fertility will
have an asymmetrical effect, with some countries
expected to grow in population rapidly as others
decrease. Increasing life spans and declining fertility rates will lead to a steadily aging population
throughout the developed world; by 2050, the
earth will almost certainly have more people in
middle age and older than younger than 40. This
will bring substantial ramifications for the global
economy, as declining fertility rates have traditionally been accompanied by declines in economic
growth. A transformation will occur and likely
reshape every dimension of the economy and society, starting in places such as the United States,
Canada, Western Europe and Japan—and even
China, Macao and Korea.
The other demographic trend with major
implications to business is “hyper-urbanization.”
The majority of people now live in urban areas,
which will see most of the population growth
in the next 40 years. By 2025, there will likely be
at least 27 cities with populations of more than
10 million. By 2050, nearly 70 percent of the earth’s
population—6.4 billion people—will be urbanized. More people will be consuming while fewer
will live in rural areas to produce raw materials.
The looming scarcity of food, water and
energy will increase marketplace volatility as well.
The present situation is unbalanced—2.3 billion
adults are overweight, while more than one billion
people suffer from hunger. Demand for agricultural products is growing more quickly than the
population, as more people transition from grainbased to meat-based diets.
While technology breakthroughs continue to
improve crop yields, there is no parallel manner in
which water production can be increased. Water
use is growing twice as quickly as the population.
A mere 12 countries preside over 62 percent of the
world’s total fresh water, which will bring significant implications as shortages increase. Forty percent of the world’s population lives in river basins
shared by multiple countries, setting the stage for
potential conflicts over water rights.
Fossil fuels continue to be the dominant
source of energy despite increasing prices for coal,
petroleum and natural gas worldwide. Developing
countries are beginning to use more energy than
some developed ones, making for a seemingly
unsustainable trend in which a full 80 percent
of the globe’s ever-growing energy demand may
be met with fossil fuels through 2035 despite the
hype around alternate energy sources. There are
a number of high-consequence “wildcards”
around energy that may further constrain supply,
including security (most oil is transported through
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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a half-dozen or so geographic choke points) and
national environmental policy designed to wean
people away from carbon.
The nexus of food, water and energy demand
creates a “perfect storm” around resource constraints moving forward, especially in terms of how
the latter two are needed to produce the former.
Agricultural demand continues to rise, leading to
deforestation for agricultural use and desertification where land is mismanaged. Other land is
Advancements
in
technology
and knowledge management are
changing the way business is done
and lives are lived.
being lost to pollution. Dietary transitions are
increasing water use, as more crops are needed to
feed livestock.
The global economy will continue to grow
and diverge as developing countries continue to
grow, and with it, a new middle class of consumers will emerge. China’s economy recently outgrew Japan’s (when expressed in purchasing-powerparity terms); and within 20 years, it will likely
overtake the United States to become the world’s
largest. Global consumption will move south
and east very quickly as Asia, the Middle East
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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and Africa enter the middle class; Asia is expected
to have five times more middle class consumers
than the United States in 20 years. Output from
the developing world will increase rapidly as more
than one billion people join the global workforce.
European nations will be pressed by sovereign
debt, which will likely eat away at the social safety
net in these countries lacking government funds,
and will potentially lead to countries abandoning
the European Union even as the working age
population shrinks — and with it these
countries’ economies.
Technology and knowledge
advancements are creating enormous
opportunities, changing the way business
is done and lives are lived. Information
technology and improved access to communications are at the core of the change
that is sweeping the world. Biotechnology
promises a host of potential gamechanging improvements as well, while
nanotechnology is rapidly improving
materials science. Combined with robotics, this
combination of scientific advancements suggest
hosts of possibilities to improve people’s lives
in ways both big and small — and for companies
to grow their business tremendously.
The geopolitical landscape continues to
change; every major world power faces some
degree of political and economic transformation.
The United States faces a seemingly inevitable
decline in economic and political standing, with
the question being how jarring or gradual the
transition will prove to be. China will soon be
A.T. Kearney
undertaking a critical change in leadership and
continues to move away from years of military
rule. The European Union faces a host of challenges, including questions about its very existence. Japan is aging rapidly and facing a huge
debt, a situation that foreshadows the future for
other advanced economies.1 India must reconcile
the growing disparity between regions that have
undergone rapid economic growth and those that
have fallen behind — “old” and “new” India will
be challenged to reconcile. Russia has abundant
resources but a dwindling population and must
determine whether or not it will become a fullfledged democratic nation and whether it will
belong to Europe or Asia — or carve out some
third path.
1
Collectively, the five meta-forces make
a strong case that continued volatility and disparity will prove to be the norm across the globe
in coming years. How the cards come to be
played will matter as well, of course: Global strife
would certainly make for a bleaker outlook, while
technology improvements may help to overcome
the significant challenges that the world faces.
Economies of scale will be required to make
breakthrough advancements a meaningful reality
in people’s lives. Whether it’s a crisis or an opportunity for companies will depend on many
individual factors, from industry and geography
to their flexibility to a changing future and their
ability to balance quarterly performance and
long-term strategic planning.
This analysis was prior to the March earthquake and tsunami, which will significantly alter Japan’s landscape over the next five years.
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
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CPO Strategy Session Participants
Participants
John Ballard
The Ohio State University Medical Center
(OSUMC)
Director, Strategic Sourcing & Purchasing
John.Ballard@osumc.edu
David Hargraves
Senior Director, Clinical Supply Chain
UPMC
hargravesda@upmc.edu
David McLain
Del Monte Foods
Vice President and Chief Procurement Officer
david.mclain@delmonte.com
Radhika Batra
Owens-Illinois, Inc.
Chief Procurement Officer
Radhika.Batra@o-i.com
Juan Molina
Westinghouse Electric Company, LLC
Vice President, Supply Management
molinajj@westinghouse.com
Christine Breves
Alcoa Inc.
Vice President, Procurement
christie.breves@alcoa.com
James Vespoli
PNC
Chief Procurement Officer
james.vespoli@pnc.com
Marcio DaCosta
Firmenich
Global Purchasing Director—Flavors
marcio.dacosta@firmenich.com
Mike Duffy
Cardinal Health
Executive Vice President, Operations,
Medical Segment
mike.duffy@cardinal.com
A.T. Kearney hosts
Walter Alvendia
Director
Walter.Alvendia@atkearney.com
Mark Clouse
Partner
Mark.Clouse@atkearney.com
Mike Evans
Industrial Scientific Corporation
Global Director, Supply Chain
mevans@indsci.com
John Foody
Alcoa Inc.
Global Director, Indirect Commodity Management
John.Foody@alcoa.com
Ernest Gabbard
Allegheny Technologies Incorporated
Director, Strategic Sourcing
Ernest.Gabbard@ATImetals.com
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CHIEF PROCUREMENT OFFICER STRATEGY SESSION
Carrie Ericson
Vice President
Carrie.Ericson@atkearney.com
Erik Peterson
Managing Director, Global Business Policy Council
Erik.Peterson@atkearney.com
Jennifer Rademacher
Marketing Coordinator
Jennifer.Rademacher@atkearney.com
|
A.T. Kearney
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