One inflation fighting innovation your company must have
Procurement pros are looking for new ways to work internally and with suppliers to reduce inflation pressure — CPO Live Speaker, McKinsey’s Sharat Chandra Chikatmarla, shares the inflation-busting secrets of successful CPOs.
Does your company have an inflation management office? No? Well maybe you need one.
Procurement pros are under tremendous pressure to stave off higher prices as inflation continues to swell. But procurement can’t overcome the impact of global trends on its own. Successful organisations manage inflation by creating an inflation management office staffed with cross-functional teams to re-examine every purchase and vendor relationship.
At a recent CPO Live Roundtable event, Sharat Chandra Chikatmarla, Associate Partner at McKinsey & Company in Sydney, shared his experiences and research in managing inflation globally and in Australia.
The most successful organisations are not only managing inflation but are also thinking beyond the short-term situation to revise how they design, manufacture, distribute and set pricing for their products.
Historically, the top responses to the question of what your biggest problem is currently in McKinsey surveys were inflation, geopolitical disruption, and supply chain disruption. The ranking of those answers varied based on recent events. Lately, inflation has consistently ranked at the top of the list.
The current level of inflation is unanticipated, driven by rising energy prices among many other factors. In Australia, inflation stood at about 6% and is predicted to rise to 7.5% or more.
The short- and long-term factors driving inflation now include:
- Ageing population
- Evolution of global trade flows
- Post-pandemic economy
- Geopolitical instability
No country or industry is immune to these factors, leading to rising prices and shortages of commodities.
Responding to inflation with innovative leadership
Organisations with the most success managing inflation know that one department can’t solve the problem. Senior management must champion cross-functional teams that come together to form collective decisions.
One innovation is to set up an inflation management office. It’s a war room to house representatives from various stakeholders in the organisation. Supported by technology, the team can make real-time decisions based on the facts from various functions (including Commercial, Product Development, Manufacturing, Marketing, Supply Chain, and Procurement)
The procurement team contributes by providing detailed visibility into the purchasing side of the supply chain, identifying where problems may emerge, and managing the commercial aspect of projects. Similarly, manufacturing, operations, and supply chain give a micro view of the demand in the coming weeks and quarters. Other contributors include product design and labour management.
Here’s an example. One company that typically made large oil purchases faced volatility of plus or minus 5%, meaning that the pricing spread could vary 10% on a weekly basis. Previously, when the company’s reserve hit a predetermined level, it automatically ordered oil from tankers that would carry oil to port.
Now, the inflation management predicts the company’s consumption pattern for the next few weeks and quarters, and examines the pipeline of supplies from previous orders. This, coupled with market analysis, enables the team to take calculated risks, such as by placing purchases early or deferring purchases to take advantage of market shifts. These moves have beaten the market by several percentage points, creating a competitive advantage and enterprise-level value for the company.
In addition, the commercial teams provide a comprehensive view of profit margins, so that the company can decide how much of any cost increase to pass on to customers. Commercial contracts can then be linked to procurement contracts, improving management not only of budgets, but also of profitability.
This level of cooperation is not the usual in procurement processes. The lesson is to use a holistic enterprise lens to have complete visibility into each department’s environment and align suppliers. Every department or function needs to be involved in bringing this together.
Aim to make collaboration the default
Successful organisations illustrate that it’s critical to have the CEO as a champion. The CEO is the best integrator across departments or functions, so if it isn’t a priority for that person and their team, then it is highly likely that you’re leaving some value on the table.
A new way of thinking means looking beyond the standard way of doing things for the procurement folks. Don’t just look at finding the best cost. Look at how you can improve the overall margin for the business.
You may need to change the product specs, so you must involve the product and operations teams. Bring the specs into the conversation and challenge them.
Inflation is coming for every business. Make sure you design contracts so you will be able to manage the price escalations that are potentially coming and work out how to protect your costs.
The three dimensions of managing inflation
- Identify potential risk exposure. Prioritise what you need to be worried about.
- Insulate risks. Set up an inflation management office, and use analytics tools to align supply and demand to manage price escalations.
- Implementation. Take a long view of contracts and proactively contact vendors to manage price escalations with a partnership-based discussion.
Setting up an inflation management office in the short run is a good start. But consider the long-term implications. How well will your procurement team work closely with the operations team and align towards making a holistic impact on the organisation?
Strategic questions for inflation management
As your organisation tackles the challenges of inflation, a few considerations will prepare you for success. Developing cross-functional relationships and insights with senior executive ownership is critical. Procurement can’t be solely responsible for inflation response. It requires a holistic effort to ensure a holistic impact on the organisation.
- How can you have complete visibility into all the risks for your organisation?
- Are you preparing mitigation plans for these risks?
- How are you motivating your team?
- Are you bringing in new analytics capabilities?
- How will it impact your operating model?
Any industry sector that requires frontline staff – food service, retail, agricultural – is facing an acute labour shortage, which drives up wages and may reduce revenues. Some industries that seemed to be insulated from inflation, such as mining, are now feeling the effects. Commodity prices are starting to slide as costs rise.
Don’t miss the next CPO Live Roundtable. The series dives into discussions on topics facing CPOs around the globe.
Sharat Chandra Chikatmarla spoke at a recent AUSTRALIA CPO Live meeting – don’t miss future speakers of his calibre: register for the whole series!
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