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Central Procurement – the Financial Implications
by Nick Mühlemann, Director, Consulting, PwC and Sebastian di Paola, Partner, Global Corporate Treasury Solutions, PwC
Procurement is the purchase of goods and services for consumption in business operations and or resale. The purchase of goods and services accounts for a major component of the costs base of manufacturing, services and retailing companies alike. For this reason, most companies are constantly examining ways to manage procurement more effectively; for many, this means increasing the level of central control over the function. As companies grow, the opportunity to drive benefit from procurement also grows – but so do the challenges, especially where the growth is across national borders.
As companies grow, the opportunity to drive benefit from procurement also grows - but so do the challenges.
The international marketplace is now a fact of business life: value chains span countries and regions and companies have both international supplier and customer bases. In response many companies are centralising control over aspects of their supply chains. For procurement this presents specific challenges, for example how to adopt a low cost country sourcing strategy whilst balancing the need for supply flexibility and managing the risk of continuity of supply, transport cost and lead time. These complex challenges contribute to the drive to centralise control over procurement and take more of these strategic procurement decisions above the individual country level. The centralisation of procurement is typically not a goal in itself, rather a staging point on the journey to a wider supply chain or corporate centralisation programme. However, the structural changes necessary to facilitate this central control can present further opportunities to optimise financial aspects of the business, including a more tax effective structure for procurement and or the wider business.
For the treasurer, initiatives to optimise and centralise procurement processes create some important challenges, but also deliver opportunity. In particular, the impact of centralisation on the nature, visibility and location of commodity exposures means that the organisation needs to consider how commodity risks can most effectively be managed in the new structure. Equally, benefits may arise for treasury in respect of centralised FX hedging, payments and third-party financing arrangements.
To address these issues, the following article will explore how the procurement function adds value in the modern organisation and how this is shaping how the procurement function itself is organised. We will look at the implications this has for the firm’s Effective Tax Rate, and the broader opportunities it presents for the finance function in areas including commodity and FX risk management, cash pooling and reverse factoring.
A move away from banging fists on tables
To understand this increase in centralisation we must first examine the ways in which procurement delivers value to the modern organisation.
The traditional focus of the procurement department has been on driving commercial benefits – put bluntly this meant getting a better deal from the supplier, more often than not by driving down the purchase price through hard negotiations. However, this tactic can only go so far, for so long. At the end of the day suppliers need an economic sales price: they too have investors who will only fund below market returns for a finite period of time. Unless an equitable price is agreed the supplier will cease business with the customer and possibly exit the industry. So purchasing professionals have had to think more strategically and look for ways to deliver sustainable benefits through improved relationships with both the suppliers and their own internal customers. Today, a typical procurement department’s focus will have four pillars:
1. What to buy (demand management) – work with supply chain, engineering and other business customers to optimise and harmonise the specification of the product to be bought, reduce purchase volumes, and increase internal compliance to purchasing strategies (e.g., get more people to buy off negotiated contracts).