Aligning Functional Organisational Design to Company Culture & Markets (Part II)
This is the second instalment of the mini-series about organisation design.
We are convinced that if you design your organisation in line with the culture and the surrounding markets, the costly need for re-organisations and internal reshuffling can be minimised.
Today we will talk about functional design, taking the Procurement function as the guinea pig. Most of the factors and solutions we discuss here also apply to other discretionary functions in the operations space (Sales, Planning, Service, Manufacturing). If you have missed the first part of the series on corporate headquarter design, feel free to read this post first. It explains, among other things, why we call operations ‘discretionary’.
What's the best organisational design for achieving high performance in a function (here: Procurement)?
What is the right procurement setup? Central, de-central, or hybrid? If you had asked this question until 2010, many of my peers and I would have answered in the best Mandalorian: Centralisation is “the way”.
But why, you would rightly ask?
We assessed (wrongly, I might add) procurement performance in the 90s and early 2000s based on economies of scale and skill. Since we will come back to this several times, so let’s be specific about these two concepts:
In simple terms, economies of scale means: Big volume, small cost. Something that was, for a long time, the panacea to being cost-competitive in many industries. Today, with the emergence of small and smaller batch sizes due to customer demand, shorter product life cycles and, in general, higher demand and supply volatility, it feels a bit like using canons to kill sparrows.
"Economies of skill" is a term that I may have either come across in my readings or coined myself many years ago. The concept involves consolidating resources within a centralized organization to recruit top-notch talent with specialized knowledge in a particular category. In cases where buyers are responsible for multiple spend categories/markets, their understanding of each supply market decreases, resulting in higher costs. Although the idea of "10X" employees with exceptional intellect and talent is fascinating, I have rarely seen them effectively implemented. Even in large automotive companies with numerous buyers managing various components, global category leadership and management lack a comprehensive view of the global supply market. Despite their intelligence and talent, these individuals are shaped by their upbringing and regional supply market perspective. Furthermore, the more centralized decision-making is delegated to them, the more time they spend coordinating with different parts of the organization, losing touch with their primary responsibility of understanding the supply market and its players.
The argument of Economies of Scale has historically been, and often still is, the primary driver for procurement organizations. This involves bundling spending to allow the supply base to reduce overhead costs and build supply safety buffers. Additionally, resources are often bundled around capabilities in strategic category experts or activities such as service centres for tactical procurement. Finally, the hierarchical element of economies of skill involves bundling the best resources to define the necessary processes and skills for running a procurement organization. However, it is crucial to recognize that procurement cannot operate in isolation. Just organising for economies of scale can be, as the British say, ‘Penny-wise, but Pound foolish’. While you can optimize input costs such as raw materials and services, Procurement is only one of several operational functions that must align with the broader context of the organization and its culture. And this is where the real magic happens…
Aligning with the firm's organisational set-up
When an organisation is decentralised, and business targets are achieved through regional or business unit autonomy, procurement functions should also be decentralised. The modest gains achieved through economies of scale are outweighed by the increased coordination efforts and potential latency associated with centralised procurement, as well as the exclusion from management circles where centralised personnel (the most common joke is: “Hi, I am from headquarters and here to help: please fill out my excel sheet”.) may not be readily accepted.
In a highly centralized organization, assessing whether your supply markets are also organized similarly is essential. While your customers may demand centralization in the front end, particularly in B2B relationships with large multinational global players, your manufacturing and supply base may still be optimally organized decentrally. Ignoring this fact and continuing to purchase centrally may lead to increased costs and reduced innovation due to the lack of local supply knowledge. I have frequently observed more innovative solutions and better pricing from agile companies aligned with the supply markets than from some large companies I have worked with.
It is important to acknowledge the dark side of organizational design, based not on facts but oversized "egos". Some leaders still adopt Machiavellian approaches by building insular, hierarchical solutions, either at the functional or business unit levels. Instead of using influence and cooperation, they rely on direction and autocracy. These leaders exist in every company, and as long as they succeed in their little sandbox, the card house they build remains standing. During my business career, I have encountered many of these individuals, and each of them had their little empire with procurement, sales, operations, etc., or an unnecessarily centralised function. Both of these ultimately failed over time, resulting in quite harsh negative margin and revenue consequences for a company and the company culture. As one colleague succinctly said, "They starve the goose that laid the golden eggs.". It is astonishing that most modern HR processes are still unable to operationalize the detection of what psychologists call the "dark triad" of personality traits, namely, Machiavellianism, Narcissism, and a Lack of Empathy in employees and later leaders. As I was told, it is a simple test to take…
Aligning with the firm's culture
Now, let’s look at the cultural context of functional design: There are many models to assess corporate culture. The model that worked for me in the last 15 years is from the book “Die 3 Faktoren des Einkaufs” (The three factors of Procurement”) by S.Schumacher, H.Schiele, M.Contzen, T.Zachau, 2008. They use a two-dimensional matrix of the degree of governance (leading via organisation and process vs leading via targets and strong personalities) and decision style (consent vs hierarchy driven).
Once internalised, it allowed me quickly to design procurement organisations in line with the companies’ culture or even say “thank you, but no thank you” to job offers from firms where I felt that their culture did not align with what they wanted me to do with their procurement:
Aspiring to have a centralised procurement when the governance happens via individual business targets or is driven by consent is as much a fool's errand as it is to continue with a decentral procurement set-up in an organisation with a transparent process-driven culture and strong hierarchical decision structures.
Now, some will tell you that there is a golden path to get all of the above and more: it is called the “hybrid” functional model. I will not spend too much time on this since I have found that it takes a tremendous effort from the CPO and the procurement leadership team to keep this up and running - balancing out all forces of the organisation. In my view, it is not worth the effort.
Our approach to functional design
While there is no one-size-fits-all approach to organizational design for procurement, it is important to consider factors such as “fit-for-function” and “fit-the-culture” alignment. Based on my over three decades of experience in running operations, supply chains, and procurements across five industries, I have found that the most effective organisational, functional design approach involves small, decentralized units operating interdependently within the larger organizational hierarchy. These units must be connected via a structured virtual knowledge network, with governance "swim lanes" such as payment terms, contracts, skill levels, training, functional career paths as needed, and systems linked through centrally provided data lakes. This decentralized set-up boasts high levels of agility and digitalization.
One exception: For fully centralized organizations, overall design and culture should remain the primary focus; hence, the centralized functional design for procurement would prevail.
And a word concerning the span of control of the organizational setup: Units (for example, strategic sourcing teams) should be large enough to reduce the micromanagement of managers but small enough to allow for effective interaction. Some general guidelines suggest that the ideal size of a departmental unit can range from 5 to 12 people. This is known as the "Dunbar's number," named after anthropologist Robin Dunbar, who proposed that humans can comfortably maintain social relationships with a maximum of 150 people, with smaller groups being more effective in communication and coordination.
Identifying the gap/opportunity
We are now equipped to see whether we can identify a gap and use this as an opportunity to close it. Let’s start by identifying where your company is on the spectrum of functional design and whether a gap reveals itself when you review the statements below. How many of the below questions can you answer with a resounding, fact-based "yes"?
Our procurement organization is aligned with the overall company organization, whether centrally, by business unit, or by geography.
Our supply chain has minimal disruptions, including delayed deliveries and unexpected increases in material costs.
Performance is consistently tracked throughout the company, including metrics such as cost reduction, number of suppliers, procurement-to-payment time, greenhouse gas emissions of suppliers and other sustainability metrics.
Our procurement organization is competitive within our industry regarding productivity and spending per employee. Any deviation from this benchmark is a deliberate decision in line with our organisational setup.
Each division, business unit, and function within our company feel valued by procurement efforts.
Our procurement is adequately funded, and acknowledged by the head of procurement/supply chain and through industry benchmarks.
Our supply base is smaller in comparison to our competitors.
Our procurement team is incentivized based on the overall performance of the business area they are connected to.
The corporate overhead for this function is less than 10% of the overall cost.
Procurement does not report to the head of the supply chain unless the person held a previous position as the chief procurement officer.
If you answered „yes“ to most questions, great: you have your organisational procurement design under control. Congratulations - well done! Do not read any further. Better to focus on other topics.
Size of the prize
However, if you do not know or answered several questions with a "no", you can make your company more stable and competitive.
To understand the „size of the prize“, please use these simple steps to establish the gap and a target:
Short-term
Establish your annual cost reduction level over the last 3-5 years (Bonus question: Do you believe the reporting ? Are finance, business unit management, and procurement aligned ?)
If between 2-3%, set a 4-5% target for the next two years. This is your gross margin improvement level opportunity - the size of the prize.
Long-term
Set a joint target between organisationally aligned sales, operations and procurement (= Buy/Make/sell) of 5+% gross margin improvement based on cross-functional optimisation projects - annually for three years.
Establish a transparent cost tool with finance that helps you ensure that the gross margin increase is used towards EBIT and investments in the future (i.e. innovation).
How to set up an organisational procurement alignment?
Time plan: 15 months (3 months blueprint design, 12 months implementation)
Board Sponsor: CEO or CFO
Lead: Head of Procurement or Head of Operations
Project set-up: Work with HR on establishing the firm's organizational and cultural design. Build a new/updated functional blueprint. After board agreement, establish a weekly task force with clear objectives following the blueprint design, quarterly reporting on management board level by CPO with clear output KPIs (i.e. design finalised and approved; the number of categories in new control; # of HC in new design set-up; % of categories covered via category strategies; the trend of supplier reduction; suppliers selected in line with swim lanes)
Sustain success: Communicate successes regularly with the new set-up, review quarterly with business / regional presidents and functional leaders the new set-up based on clear KPIs agreed upfront
Digitalization/Automation opportunity: MEDIUM - The time of big ERP systems to support organizational design solutions is long gone. With the right APIs and process mining software, every system in each corner of the corporation can be cleaned up and linked to a large data lake, which can be used for spotting optimization potential, monitoring compliance, and cross-sharing of suppliers and solutions.
Risk: LOW - Procurement is like a bicycle. You will always get from point A to point B. The right bicycle and care will decide how quickly you get there and how much effort it takes. Changing procurement wrongly will not break the company, but it might cost you percentages of gross margin and unhappy customers for a while.
Cost: LOW - Either set up an internal task force full-time or employ external support. If external support is used, as always, we recommend having internal resources shadow the consultants to have a knowledge transfer guaranteed.
Watch out for Stopping implementation mid-way, missing discipline in implementing change by giving in to “dark triad” business leaders in functions or business units, selecting the right functional leaders that can work in the new set-up: the old guard is not necessarily the best new guard.
Thank you for being interested in the second part of the mini-series about functional design. Hope you will enjoy as well part three when we talk about roles & responsibilities, competency, and job design. We will show that the design works around a division of labour are as important today as when invented in the 19th century.
Stay safe. Be bold.
Daniel
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