mckinsey on procure-to-pay driving procure-to-pay (p2p

Driving Procure-to-Pay (P2P) excellence to realize the full value from strategic sourcing

January 2015

Mauro ErriquezAndrew LeSueurJeff HartMilan PrilepokEdward Woodcock

McKinsey on Procure-to-Pay

1Driving Procure-to-Pay (P2P) excellence to realize the full value from strategic sourcing

With 60-80 percent of a Company’s costs being spent with third parties for goods and services, strategic sourcing and supplier relationship management have been key areas of focus for most organizations. However, while companies are quick to identify and celebrate cost savings from strategic sourcing programs, many struggle to have the identified savings reach the bottom line.

Investment in procure-to-pay solutions was expected to enable realization of contracted savings and enable end user self-services, while freeing up time for buyers to engage more effectively with business partners. However, in our experience, most buyers remain mired in day-to-day “fire fighting” – chasing POs, following up on late orders and dealing with manual paperwork and processing. This leads to a perception from other parts of the organization that the procurement function is a ‘traffic cop’, slowing down business strategy execution instead of being a ‘co-pilot.’ Further aggravating the situation is the lack of transparency and agreed upon performance metrics that procurement provides to the business partners.

In our view, there are 4 shortfalls most companies encounter which drive savings leakage and process inefficiency:

1. Disconnects across the P2P chain

Few companies are organized for end-to-end ownership of P2P (Exhibit 1) service delivery of business impact (e.g., total external spend and working capital improvement, supplier innovation, etc.) to end users/functions. Today, most procurement functions have implemented category management strategies - data-rich, fact-based sourcing relationships with preferred suppliers using formal contracts. However, when it comes to procuring against these contracts, we see a dramatic drop in actual benefit realized due to significant value leakage – frequently in the range of 1-3% of unrealized savings across the entire spend base (Exhibit 2). “We have great contracts with the appropriate suppliers, yet we’re not seeing all the savings, which we know are there, fall to the bottom line,” said one chief procurement officer (CPO) for a large US-based packaged foods company.

Introduction: Common challenges institutions encounter with P2P

Exhibit 1P2P as it fits within the overall sourcing process

SOURCE: McKinsey & Company Purchasing & Supply Management Practice

Focus of this document

Procurement analytics

Vendor selection & negotiation

Spend category strategy

Procure-to-Pay

Procurement & Legal

Supplier relationship management

Accounts Payable

Purchase Requisition approval

Purchase Ordergeneration

Invoice receipt and processing

Payment processing

Vendor management

Procurement &Compliance

ProcurementProcurement & business areas

Source-to-Procure

Master data management

Systems Support

Procurement and IT

Components of an end-to-end Source-to-Pay system

Procure-to-Invoice Invoice-to-Pay

32 Driving Procure-to-Pay (P2P) excellence to realize the full value from strategic sourcing

Additional examples –

� A central procurement function for a large Oil & Gas provider signed a global contract with an IT Hardware provider, but the local businesses continued to buy from the local IT dealer paying more than 20% than the contract with the preferred supplier

� One large division of a Healthcare provider continued to pay its IT service provider based on old rates even though Central IT procurement had negotiated a 15% discount

� A category manager for a large utilities company did not buy off central procurement’s newly negotiated contract for safety supplies, as a result the company lost out on ~$8 million in savings for one year

� A department of a professional services company continued to pay an insurance premium in excess of ~$5 million per annum when actual claims were just $13 thousand over the last 9 years

2. End users do not have visibility into contracted spend and alternate procurement channels

A prominent driver of spend leakage is the difficulty end users have in accessing and understanding who the preferred suppliers might be and which are already under contract. Frequently, end users do not have the time, nor the training to determine who are the preferred materials and services vendors . This situation becomes further complicated when an institution is decentralized with many end-users making buying decisions.

Exhibit 2Immature P2P processes can cost organizations 1-3% of total spend every year in value leakage


Potential value leakage Example – Client with 20bn spend

Uncontrolled(Maverick) spend 100 - 200

Higher transactioncosts

Not buying oncontracts

~200+ million

Inefficient procurementorganization

7 - 10

Total value leakage

10 - 15

100 - 150

Observations

▪ 25 - 50% of purchases are not done via procurement or purchase order

▪ 15 - 30% of purchases do not comply with contracts (e.g., done through RFQ even though a price-negotiated contract exists)

▪ 20 - 30% reduction in FTE and moving to lower wage countries (e.g., costly, labor-intensive overhead)

▪ 5 - 10% of transactions require rework, invoice reconciliation, fail to recoverpayment discounts

▪ 1-3% of total spend is lost in brokenP2P system

ILLUSTRATIVE EXAMPLE

In our experience, we find the lack of transparency about preferred suppliers generates significant non-value added demand on the procurement operations organization. Team members will spend time researching existing contracts/validating user specifications vs. focusing on creating value from non-contracted or spot buy spend. Senior business leaders and procurement routinely hear from frustrated end users about purchasing delays and inflexible purchasing processes. In one case, the purchasing department was taking 15-20 business days to issue POs against contract based requisitions. Root cause analysis identified that the end users were spending time generating quotes from non-preferred suppliers and attaching them to requisitions, while the company already had contracts with preferred vendors. The purchasing department was searching contracts manually and going back to the end users to validate needs and specifications, practically re-creating the requisition on the available contracted item.

Another notable example is a global mining company, which was trying to increasee spend compliance across the organization. After several months of investigation, it identified more than 40% of spend was not going through procurement, and, of the remaining spend where procurement was involved, less than 25% was actually compliant when compared to the formal procurement policies. The primary contributor to the low compliance was a lack of a systematic approach to uncover, report, and prevent this specific behavior earlier in the process.

3. Lack of fully integrated approach to manage the various systems and tools

Based on a confluence of factors including: maintaining specific business requirements, delayed migration of activity ownership, limited integration of acquisitions, and costs, P2P systems tend to be highly fragmented. For example, it is quite common to see limited/no integration of legacy contract management with enterprise purchasing systems or purchasing systems with invoicing/payables systems.

In our experience less than a fifth of organizations have all their contracts available in a digital form in a centralized repository. Contracts and addendums continue to be located as hard copies in the desks of buyers across the organization. Discussions with many institutions who have managed to migrate to the digital domain, uncover basic issues such as lower percentage of spend using approved contracts and vendors. Often lack of training is flagged as a key concern.

Legacy ERP user interfaces were not designed for the average light-end users. With the growth in consumer eCommerce, most end-users are now quite familiar with self-service ‘shopping’ and checking out of ‘shopping carts’ and question their legacy corporate requisitioning processes that often do not have marketplace and/or punch-out electronic catalog capabilities. Furthermore, most ERP’s were initially not enabled to support mobile users on tablets and smart phones – thereby requiring access to a computer to do even relatively simple tasks such as reviewing and approving requisitions on the go. An additional complication with ERP systems is that their architecture design is not aligned with the purchasing processes, and therefore numerous functionality gaps exist such as:

� Master data setup is redundant and inefficient. Many large companies have at least three systems that they need their vendor master data in: (1) ERP - which is typically the “source of truth”, (2) eProcurement tool/P2P – over time this becomes out of synch with the ERP system/“source of truth”, (3) SRM / Vendor Management system – which is almost always separate from the ERP because ERP vendor masters do not maintain the relationship information including key contacts, history of vendor relationship, etc.

� Outbound interfaces from eProcurement tool/P2P to ERP create kickouts and consume support teams’ time. Standard APIs are available with most eProcurement tools to ease integration with ERPs. However, most ERPs still require internal customization in order to accept and map the inbound data correctly.


4. Limited change management and capability building across P2P and end users

In our experience, the lack of trust/alignment between business and procurement is often the result of the lack of clarity on the operating model – the roles and responsibilities between the business unit (demand) and procurement (supply) particularly around where and how to order and then efficiently pay for goods an services. Further, many procurement professionals are not close enough to their stakeholders to understand the ongoing business performance dialogs and business strategy, leaving procurement focused only on cost reduction vs. core business needs like speed to market, commercialize/scale innovation, flexible business models, supply reliability, etc. This requires a change in mindsets and capabilities for front line procurement staff.

A common scenario we find in accounts payable (AP) departments is the focus on timely supplier payments (per payment terms) – but limited focus on the end to end invoice to pay cycletime. AP departments that collaborate with procurement operations to receive first time right invoices (via PO flip/electronic invoices, etc.) and automated three/four-way matching can enable a company to leverage the rapid payment capability into a negotiating dynamic, early payment discounts with suppliers. This way, suppliers achieve flexibility to manage their cashflows, while the company can achieve an ROI of approximately 20-25% on working capital invested.

The value of P2P excellenceOur experience indicates that implementing a best-in-class P2P system drives increases in process efficiency, spend transparency and better controls to improve the quality of and credibility of procurement performance and enables full capture of procurement savings.

1. Improved compliance including increased percent of spend with a PO, spend under contract with approved suppliers, spend on approved items and services, and elimination of purchases by non-designated staff.

A European Oil and Gas company generated ~$100M (2% of total spend) in EBIT improvement by implementing a robust P2P system to improve compliance on contracts and eliminate invoice errors and duplication; in another case, the organization implemented a two-year P2P transformation to improve data accuracy and reduce process lead-times (thereby reducing number of days of inventory held) to generate an EBIT improvement of over $50M (1% of total spend).

2. Optimized cost of P2P administration including increasing the productivity of buyers (spend per buyer), lowering the average cost of processing purchase orders and invoices, increasing the percent of self-service electronic catalog based spend, increasing the percentage of p-card penetration and the percentage of electronic suppliers’ invoices.

A North American packaged goods company reduced P2P FTEs, improved PO coverage (spend through POs) to 90%, reduced purchasing transaction cost by 25%, and purchase requisition(PR) to purchase order (PO) cycle times by more than 30%.

A North American Pharmaceutical company saved ~$25M by streamlining its P2P process and systems through capturing discounts on early payments in the contracts, consolidation of P2P transactional activities with a single BPO provider, increasing electronic invoicing to >95%, standardizing payment terms and enforcing p-card payments for spend <$500 per transaction. The organization also reduced payables transactions errors by 80% and reduced disputes with suppliers significantly enabling a more conducive environment for negotiating better discounts.

3. Improved effectiveness through reducing the purchase requisition (PR) to purchase order (PO) cycle time, invoice -to-pay cycle time, and increasing the percentage of PO based invoices are examples of improved performance metrics clients identified as a result of addressing the P2P opportunity.

In 18 months, another European chemicals company, reduced PR to PO (purchase request to purchase order) cycle lead time by 60%, invoice errors by 80% and achieved more than 85% compliance to purchase orders and contracts.

4. Higher stakeholder satisfaction and engagement – many clients experienced higher service quality to internal customers and raised the credibility of, and engagement with their stakeholders. A robust P2P process becomes a key contributor to the organization’s efforts to increase compliance, lower operational risks such as stock-outs, double ordering, erroneous invoice processing, and reduce legal risks by providing more diligent fraud protection.

A North American agribusiness increased PO coverage from 45% - 85%, and increased compliance on purchasing policy and processes. This increased compliance had a tremendous halo effect, enabling purchasing to be invited to numerous other working teams on business issues more strategic in nature.

5. Improvement in working capital. Optimizing payment terms and/or investing in dynamic discounting with suppliers, avoiding late payment interest through on-time payments.

A global beverage company with a large volume of non-PO invoices was challenged to improve the cost of administering low value, high volume invoices while at the same time enabling supplier liquidity. The company’s analysis showed one segment of its supply base was paying significantly higher interest rates to receivables factoring firms – which represented cash flow being ‘leaked’ from the extended supply chain. The beverage company determined that its cost of capital would enable it to provide a more competitive interest rate to its suppliers – via early payments in return for a discount. The company implemented a dynamic discounting tool in conjunction with its legacy ERP system to offer an attractive, flexible liquidity management solution. Approximately 50% of the targeted suppliers opted in for the automated dynamic discounting


approach, while the rest opted to control their early payments on a need basis. The solution turned out to be a win-win for the company and their suppliers as the latter consolidated their factoring with their customer (while retaining flexibility) and the former earned a far better return on its working capital investments vs. traditional Treasury operations.

All of the clients we interviewed indicated that the benefits from investing in improved P2P processes and systems are significant and clearly evident. “Fixing P2P is about realizing and executing the good work done in sourcing”, the COO of TD Ameritrade, Marv Adams, said in a February 2014 McKinsey interview. Many companies experience “cost reduction fatigue” – it becomes harder and harder to excite stakeholders about an additional cost reduction initiative and they may “tune out” procurement cost initiatives. However, for many companies, if the business case can be made that the P2P initiative will result in meaningful cycle time and response time improvements and preserve savings, stakeholders and buyers will be much more engaged in becoming part of the solution.

Over 80% of the companies interviewed indicated that it’s not really a question of if there is a compelling argument to invest in a P2P process transformation, as the business case and ROI clearly justify the investment, but more about how to do this most effectively.

So what should companies do? Most of the purchasing leaders that we interviewed indicated that the inefficiencies and value leakage along the procure-to-pay value chain are the key factors driving frustration for end users. Further, they also indicated that investing and setting up robust P2P systems can help address these performance gaps, as long as the purchasing channels are backstopped by clear business goals and performance metrics. As the procurement leader of a global mining company commented, “the primary reason companies have so much leakage here in the P2P area, is they don’t realize the value at stake, and haven’t established clear metrics to drive the focus and behavior.”

1. As a starting point, purchasing and finance leaders need to be aligned at the top to assess P2P processes and assign end-to-end purchasing channel responsibilities instead of the traditional purchasing and finance functions operating as silos without a shared and clear understanding of the operating model and objectives. Leading institutions employ an operating model where finance and purchasing have a formal cadence of interactions, alignment on roles, and consistently collaborate to identify and fix the break-points in the system.

2. Implement an automated guided ‘shopping’ and requisitioning approach - automation of POs and having curated eCatalog marketplaces/ preferred supplier search integrated into the requisitioning process enables end users to quickly search and compare their requirements and make better purchasing decisions.

Further, for selections from preferred sources and contracts – end users could use purchase cards (p-cards) to directly settle their purchases, thereby reducing downstream demand on accounts payable while securing additional card rebates and optimizing working capital. Enabling online, self-service access to this information, electronic alerts for exceptions – enable the business to pro-actively manage spend opportunities.

3. Organizations need to map their ‘To Be’ purchasing channels to the enabling systems and identify the gaps in terms of impact on business outcomes with clear KPIs (e.g., cycle-time to process requisitions, purchase orders, supplier invoice payments, etc.)

With advances in P2P technologies, integration, cloud and mobile solutions – there are a variety of options, but each needs to be tailored to the organization’s operating environment. Some of these technologies like cloud based solutions enable deferment of capital expenditure and pay per use models, besides accelerated deployment due to shared IT infrastructure.

Other delivery models include leverage of P2P BPO partners, who can provide platform solutions and support (aka ‘Business Process as a Service’ models). Regardless of the technology platform, a joint business-procurement view of business impact such as realized savings, spend leakage by category, supplier on-time payments, focuses dialog on value creation. Having a robust baseline of end-to-end business impact metrics is critical to identifying and prioritizing sources of value creation across the P2P value chain (Exhibit 3).

Exhibit 3Metrics should be aligned to the business outcomes needed at each stage of the process…


ILLUSTRATIVESource-to-Pay

Category mgmt. Contract admin Procurement Ops Accounts payable

▪ Supplier master data management quality issues

▪ Manual purchase orders

▪ Limited, timely receiving online by requisitioners

▪ Non-PO invoices, direct reimbursement requests (vouchers)

▪ Incomplete supplier invoice information

▪ Delayed payments – loss of discounts

▪ Inadequate spend visibility

▪ Limited spend under management (e.g., marketing and comms spend managed by Marketing)

▪ Limited contract visibility/compliance by end users

▪ Manual processes for shopping for contracted items

▪ RFX for existing contracted items/services

% spend visibility % spend under

management (direct/indirect)

% contracts on ecatalogs

% spend on contracts via ecatalogs

% ecatalog spend on p-cards

% supplier master data accuracy

% PO based invoices

% PO based invoices % paid on time Invoice to pay cycle-

time % discount

captured/eligible

Effectiveness metrics

End-to-endbusiness impact outcomes:

▪ Days payable outstanding (DPO)

▪ % total spend improvement

▪ End-to-end transaction cost

▪ Customer satisfaction

8

4. Moving from a legacy siloed functional model of purchasing and finance services to an integrated P2P service offering requires an internal campaign approach to training and capability building with not only end users, but also within purchasing and finance. Part of the campaign also needs to address mindset and behavior changes with end users. Nearly all of the clients we interviewed indicated that they underestimated the change management aspect of their P2P transformation, which slowed adoption.

Senior purchasing and finance leaders can role model the cooperation by actively participating in P2P performance review meetings and in key spend category strategy meetings with business leaders. Taking a customer driven approach with end users and suppliers to periodically survey P2P satisfaction will uncover continuous improvement opportunities. Finally, the organization needs to invest in change management and communications to help raise awareness of the proposed changes, gain the “buy-in” of end users and ensure that the spotlight remains focused on the new way of working.

Conclusion

Purchased materials and services make up 60 to 80 percent of a product’s total cost in many industries. Companies that do not invest appropriately in the purchasing team’s capabilities and culture are throwing away more value than they realize. Organizations that employ leading-edge purchasing practices achieve almost double the margins of companies with below-average purchasing departments (20.2 percent versus 10.9 percent, respectively).

To that end, strategic sourcing without a robust procure-to-pay system and supporting processes is like trying to row a leaky boat to shore – the more you row, the slower you go and perhaps eventually sink under the weight of inefficiency, savings targets that go unmet and frustrated stakeholders. Investing the time and energy in procure-to-pay will help to ensure a safer passage to sustainable, tangible impact.

mckinsey on procure-to-pay driving procure-to-pay (p2p

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