11 August 2011 | Tony Davies
Make sure you really understand what added value means – it will enable you to get to grips with buying.
Throughout the CIPS qualifications scheme, a number of learning objectives refer to how procurement can ‘add value’ to an organisation. Students usually answer questions on this subject by trotting out a range of ‘best practice’ principles without really demonstrating how these specifically add value to the organisation. Here is some advice to encourage you to develop a broader and more sophisticated response to such questions.
The first problem is how to define added value. Value is the relative worth or importance of an attribute or feature, while added value refers to the increase in worth of a product or service as a result of a particular activity. Added value can be viewed as a marketing concept (increasing the price that customers will pay by providing additional benefits), or an economic concept (reducing the cost of producing a good or service). Value should always be considered in relation to the end customer.
Procurement can add value through lowering the cost of supply, or by increasing functionality – quality, delivery, additional features, responsiveness, flexibility, perceived exclusivity. To add value, a buyer must understand how procurement actions affect the strategic goals of the organisation, which for a private sector organisation are to increase revenues and/or to increase returns, and to achieve competitive advantage.
Reducing the cost of supply enables an organisation to either maintain prices and make more profit from its existing sales, or lower prices and thus increase its revenues. Increasing functionality, on the other hand, enables an organisation to either raise prices and increase its returns, or maintain prices and improve its sales.
2. Strategic drivers
It is important procurement professionals understand the strategic drivers of the organisation and how it achieves competitive advantage. For example, the buyer within an organisation that pursues a competitive strategy of cost leadership, such as a low-cost airline or a soup manufacturer, predominantly adds value by seeking cost reduction.
In contrast, a buyer working for an organisation that follows a differentiation strategy would place more emphasis on increasing functionality. A fast-fashion company, for example, will value flexibility. The emergency services require responsiveness. And a luxury goods manufacturer seeks exclusivity.
There is obviously an element of trade-off between cost reduction and functionality improvement, so buyers need to be aware of the value requirement (cost versus functionality) of their internal and external customers. This is not to say purchasers should blindly pursue one strategy to the detriment of the other. Cost leaders should reduce supply costs as far as possible without compromising the required level of functionality, while differentiators must ensure that additional benefits do not result in prices that exceed that which the customer is willing to pay.
3. Value analysis
At the operational level, buyers may conduct a value analysis exercise in order to add value. This is a systematic effort to improve upon cost and/or functionality by breaking down products or services into discrete elements in order to examine their relative worth. Value analysis seeks to answer the following questions:
• What is the function of the element?
• Is the function necessary?
• Can a lower cost alternative be identified?
• Can the element be simplified or its specification relaxed?
• Can it be redesigned to be produced more efficiently?
• Can features that the customer values be added?
• Can elements be integrated more effectively?
By understanding the strategic drivers and the value requirement of customers, the purchaser is able to undertake activities that add value to the organisation.
3 key points
1. Understand the definition of added value
2. Learn how your organisation achieves competitive advantage
3. Make a value analysis – examine the relative worth of products or services