In March of 2014, Matthew Eatough, CEO of Proxima Group, wrote an article for Harvard Business Review discussing what he called ‘corporate virtualization‘. The concept is based on research that found that, on average, “69.9% of corporate revenue is directed toward externalized, supplier-driven costs.” The fact that such a large percentage of corporate revenue is spent with external business partners is surprising enough, but the study also uncovered that the percentage increased by 4% from 2011 to 2014, marking a clear trend towards more reliance on suppliers rather than less.
These findings should have completely rocked the world of procurement, and opened the eyes of C-level executives hesitant to embrace the full value proposition of a strategic procurement function. And yet, they changed little for the vast majority of organizations. But why?
Reason #1: C-level Executives don’t know.
The CFOs of the companies participating in the study were asked to report what percentage of their revenues was spent with external parties. They were almost all wrong, and significantly underestimated (sometimes by double digits) how much their company spent with suppliers. If these executives, selected to participate in such research, did not have the answer to that question, it is unlikely that any given CFO has that information either.
Reason #2: Procurement hasn’t told them.
For the most part, procurement professionals continue to struggle with metrics that emphasize cost reduction rather than value creation. Finance thinks our numbers are all made up, and the CEO often forgets we exist. There is even a disconnect between our performance metrics and the way the rest of the organization sees commercial activity. The denominators we use in most of our calculations (think historical spend, or addressable spend) are usually modified enough that the resulting figures are only relevant to procurement’s own purposes.
Conversely, looking to capture and represent the idea of corporate virtualization brings a company-wide perspective to spend and supplier relationships. It divides total annual spend by gross revenue. Sure, this calculation includes spend that procurement considers unaddressable, but it demonstrates the need for many of our initiatives – supplier management, contract management, category management – whether the spend will be strategically sourced or not.
Over time, strategies such as vertical dis-integration have gradually moved headcount, operations, risk, and capital investment out of companies and onto their suppliers. The relative importance of those suppliers increased accordingly, albeit without anyone noticing. It is time for procurement to recalibrate corporate understanding of the role of suppliers – and step up and take on the additional responsibility that will likely lead to. The corporate virtualization average will never reach 100%, but it can certainly rise from the current 70% average. Even if it holds steady for the next couple of years, there is clearly plenty of catching up to do.
Do you think your CFO knows what percent of revenues are spent with suppliers? How do you think general knowledge of that figure would change procurement’s role in the organization? Have you taken any steps to investigate corporate virtualization yourself? Share your thoughts by commenting below or tweeting @BuyersMeetPoint, @Iasta & @Selectica_inc.
This contract management webinar and associated Ardent white paper.