Jack Welch once noted that the only two departments that drive revenue directly to the bottom line are sales and procurement. He noted that the other departments were basically overhead. I would also include supply chain professionals in this revenue generating group.
The dilemma that we have is how should organizations pay the revenue generating departments of procurement or the supply chain? Sales departments are often incentivized with bonus-based pay based on sales volume, increases in market share or new customers gained. Should we pay them similar to sales? Not so fast.
Here is a story. I once had a very good steel buyer who led our steel supply chain efforts. Steel was approximately 25% of our cost of goods sold. In his review he showed that he had achieved a price reduction for the year of 2%. He focused solely on cost. However, the overall market or market basket price of steel we used had fallen 6% that year. Obviously he had not kept up to the market’s price reduction. We did have a discussion that revealed that he had a potential breakthrough project with the supplier to us a different significantly less expensive grade of steel that would reduce our steel cost by 20 %. The new grade of steel took less time to produce, was closer to our plant, required fewer inventories and had major quality improvements. For this year’s review it was mentioned but we agreed to include it in next year’s goals.
For procurement and supply chain professionals’ metrics for pay increases is much more complicated, but revenue growth or hard savings must at least ground their pay or compensation system. Unfortunately many of our colleagues cannot get past “price or cost is king.” which requires ongoing education on procurement’s part, and the use of total cost of ownership principles. There is not a shortage of focus areas to help select how to judge compensation for procurement or supply chain professionals. Quite the opposite there are almost too many! A varied market basket (multiple focus areas) approach is justified.
My first point is that when the multiple market focus areas are selected to judge compensation are selected, they should be aligned to the organizations overall vision and mission statement. They must be adjusted for the current market conditions the organization is facing. They should vary year to year based on market conditions and circumstances. In the dynamic departments of procurement and the supply chain, the worst choice would be to select a system that is inflexible and outdated. I recommend a focus area market basket approach and for simplicity no more than five or six focus areas. The list of focus areas available is large.
I realize this is a large list and that I have not gone into great detail on many of the focus areas. I am sure a procurement department can brainstorm even more focus areas. One of the most important steps is to get another department such as finance or accounting (a third party) to agree to the definition of the focus areas and the criteria. Without their buy-in, procurement’s savings or success will not be recognized.
Here are some market focus areas to consider:
Market Basket Focus Areas Hard Savings
Market Basket Focus Areas Soft Savings
Finally, I would recommend adjusting or changing the market focus areas for each procurement or supply chain professional yearly to improve their breath of skills and capabilities.