Inflation fighter and value creator: Procurement’s best-kept secret

Procurement leaders are facing their toughest state of play in many years across global markets. However, there is an opportunity to raise the bar on value creation and think long term to become a more strategic function. This episode of McKinsey Talks Operations explores how the procurement function can get ahead of turbulence to fight inflation and help organizations develop a resilient way of working.

Host Daphne Luchtenberg is joined by Craig Reed, former vice president and chief procurement officer at Corteva Agriscience, and Marta Mussacaleca and Roman Belotserkovskiy, partners in McKinsey’s Operations Practice. Ezra Greenberg, a global leader in McKinsey’s work on macroeconomic scenarios and trends also joins the discussion. Their conversation has been lightly edited for clarity.

Daphne Luchtenberg: Your company’s future success demands agile, flexible, and resilient operations. I’m your host Daphne Luchtenberg, and you’re listening to McKinsey Talks Operations, a podcast where the world’s C-suite leaders and McKinsey experts cut through the noise and uncover how to create a new operational reality.

From boardrooms to grocery stores, inflation is affecting everyone. Prices are up in the United States and across Europe. They’re even higher in other areas around the world. Russia’s invasion of Ukraine and the resulting disruptions to the energy, agriculture, and minerals markets have made it likely that inflation will be higher and more persistent than even revised expectations suggest. Businesses and consumers are already reeling and tired from two years of a global pandemic that has disrupted the decades-old model of how things are made, sourced, and delivered. Procurement leaders have told us repeatedly that this is the toughest market environment in at least 20 or 30 years.

I’m joined today by Craig Reed, former vice president and chief procurement officer at Corteva Agriscience, and two of our McKinsey Operations partners, Marta Mussacaleca and Roman Belotserkovskiy. We are going to take a closer look at how the procurement function can be both an inflation fighter and a value creator. We are also joined by Ezra Greenberg, who is a global leader in McKinsey’s work on macroeconomic scenarios and trends. In many ways, a new age of supply chain management has arrived. With that comes a growing understanding that the procurement function can raise the bar on value creation and help companies succeed.

Ezra, I’d love to begin today’s show with you. There are a lot of different views on the current state of play across global markets. Can you help us lay out some of the foundational macro trends that are shaping the context for businesses right now?

Ezra Greenberg: Yes, thank you, and happy to be here with you all today. I think the best way to understand the current context is to rewind to before the unfortunate decision by Russia to invade Ukraine. What’s the story that you would be saying? We’re getting through this Omicron wave, which has been quite devastating, and inflationary forces had built up to an extent that was quite unexpected. That was in large part driven by the supply–demand imbalances that were driven by all of the COVID shocks, and the commodity price increases that came along with that, and all the supply chain woes that we’ve all been suffering through over the last several months. You put all that together, and you’ve got these imbalances, which have resulted in significant inflation. And inflation became more persistent and more widespread across the world and across different parts of the economy.

Then with the Russian invasion of Ukraine, we had a second commodity shock that’s still passing through the system. That extra jolt is really what has pushed central banks to the point of what you’re seeing now—pretty aggressive moves to contain inflation and minimize what the impact of that might be on growth. Where does that put us today? It puts us in an uncomfortable situation.

The situation in Europe is complex because of the Russian invasion of Ukraine. They’re facing both a direct demand shock and a supply shock on energy. One of the biggest downside risks, which is Russia cutting off natural gas to Europe, seems to be coming to fruition, which, again, is holding up energy prices globally and contributing to inflation. There is a lot of volatility and a lot of uncertainty about the next 12 to 24 months. Our view is that this is not a time to try to be a crystal ball reader and do forecasts. It’s time to try to understand what’s the range of possible outcomes in terms of scenarios and which variables will matter most for your business. Then, most importantly, given all that, are you going to change what you’re doing? If there’s a recession, it will be a normal recession. It’s not COVID, it’s not the financial crisis, it will be much milder than that, but it’s still a legitimate recession. The question for your business is, is this a short-term firefighting piece or is there a significant change in your long-term strategic posture, which would cause you to do different things?

Daphne Luchtenberg: What does all this mean for the state of unemployment, especially when we keep seeing stable labor markets despite rumblings of a recession?

Ezra Greenberg: When you think about labor markets, the most important thing is to understand that labor markets are different across different countries because different policies are being followed, not only in difficult times like we’re in right now but in normal times—just as the structure of labor markets is different. If you go back to the initial COVID crisis, the initial COVID shock, in Europe, policies of furlough and the shortening of hours were followed much more directly, and the UK was somewhere in between. The disruptions in the US labor market have been massive, and that has resulted in significant wage inflation and falloffs in participation. The impacts in Europe have been less obvious because of the different policies that were found, and, again, the UK is someplace in between. One of the biggest challenges that businesses are facing globally is the search for talent and new workers.

If you think about some of the survey work that we’ve done, the impact of COVID really has been a changemaker in worker preferences globally. It’s not just about wages; but it’s about the holistic kind of atmosphere and opportunities within work. One of our colleagues who recently released this global survey data said when workers are faced with the choice between work–life balance, this time they’ve chosen life.

Daphne Luchtenberg: Exactly, Ezra, and supply chain tightness and inflation have actually been part of our lives for some time. They’ve really challenged sourcing for at least the past two years. In the next normal, we’ll definitely be defined by a high level of uncertainty. Marta, how are you seeing business leaders responding, and what have you seen be effective?

Marta Mussacaleca: That’s right, Daphne. Across the board, we’re seeing cost increases, challenges in revenue in some industries, supply, and stability, which is incredibly challenging to deal with on a day-to-day basis. Also, [we’re seeing] a talent shortage—or a change in talent preferences—like Ezra brings up, as well as challenges in setting budgets to run the companies. When we think about all these challenges and the inherent cross disciplines that they cover, the most effective course of response is cross-functional, in which executives—with the CEO at the center—work together, first, to protect margin, of course; second, to improve the resilience of the company—the last few years of shocks have really revealed where weaknesses or vulnerabilities are in the company’s supply chain and market approaches; third, to drive efficiency—controlling cost is still one of our best allies in buffering the shocks that come from the outside; and fourth, to dramatically and permanently improve the operating models—which is something that I think we’ve become quite used to in a postpandemic world.

If we accept that these types of shocks and these types of uncertainties and these types of changes in our talent profile are here to stay, then how do we adjust our operating models to respond to them? That needs to be an integrated response from across the executive room and, again, orchestrated and supported by the CEO. No one function can do this alone and do it well, which, by the way, is an evolution of this line of thinking in the last couple of years. I think when 2020 hit and at the end of 2020, early 2021, when inflation really started to spike, everyone quickly looked at procurement and said, “OK, CPOs [chief procurement officers], go solve this; let’s go cut costs somehow.” Now, we’re realizing that’s not enough.

Daphne Luchtenberg: Fantastic! Thanks, Marta. Craig, I’d love to bring you in here now. How have you and your organization adapted and changed the way you are collaborating across functions?

Craig Reed: Thanks, Daphne, I really appreciate having the opportunity to be here. I think Marta said it well. This cross-functional approach is really the only way for companies to gain momentum, stabilize, and continue to perform in a way that’s going to deliver value on behalf of their customers. In this current environment, you need clear transparency from beginning to end to be able to perform. With so much volatility, unpredictability, and challenges, as Marta mentioned, it is extremely important to enable the organization to be able to manage the situations that are occurring across this entire continuum.

This resiliency discussion is probably the most significant one now because all companies are taking a fresh look at what it means to be resilient. In the past, you were driving for productivity, and you were doing that on a global market that had some level of stability and predictability. Now that’s continuing to change, and you have to rethink what the definition of resiliency means for you and your company from a supply chain standpoint. Reevaluating that is also strategically important right now.

Daphne Luchtenberg: Craig, as we were talking about that, it prompted me to ask another question. The pandemic was of course an accelerant to restructuring supply chains, but can you talk more about some of the dynamics that were happening before that?

Craig Reed: Because the change has been happening—not necessarily change, but the demand requirements have been changing significantly over the last two and a half years since the beginning of the pandemic—even if you step back further than that, we’ve had these minishocks that have driven requirements for us to think differently, and that was sending minishocks to the system. We’ve had other scenarios that transpired—where we’ve had, for example, in the semiconductor industry, shortages of supply that have caused shocks in the system. All of these things have led up to these discussions around supply resiliency or, in the end, transparency. It just so happened with this last major shock, which has really forced them to come to the table.

If you think about the significant pressures to be able to deliver a product in the current environment, it has been extremely tough. The strategic work is what’s going to continue to allow us to deliver long-term value for the company. That means, working from a talent standpoint, that’s a very different conversation from what we used to have. Starting to develop that mental muscle in your team is what’s important. Today, we’re redesigning the organization to allow us to effectively manage what I would characterize as day-to-day work. It’s running the business that’s extremely important, it’s the firefighting on today’s challenges that pop up—you have a delay in shipment here—all of those things that are driving hands-on-deck activity. That’s along with this long-term approach of, how do you really start to drive and develop a collaborative relationship with suppliers that is going to drive long-term value? Balancing that is tough. Having a team that can work in those two dimensions is tough as well. You have to invest in the development of your teams to allow that to happen.

Now, as we think about today’s environment, you’re looking more at things related to cash management and inventory planning. You’re looking at the overall end-product design in terms of how we can look at the product more efficiently to be able to meet in-state goals, and what level of innovation can the suppliers bring to the table that you can actually leverage. Having relationships that allow both to benefit from that internal innovation is key. What we’re doing today is having discussions with key suppliers around how we can start to drive these sorts of agreements or relationships that allow us to have a mutual win, and by going a lot deeper into what are the drivers of value for both of our companies in order to accelerate those levels of opportunities to market.

Daphne Luchtenberg: Thank you, Craig, for hitting on that point. And Roman, can I come back to you? I’m curious to hear from you about what will be needed from the procurement organization. Not only today to help drive more value, but in the longer term, because there is that opportunity, isn’t there—to be an even more strategic function in the future?

Roman Belotserkovskiy: I completely agree with Craig about the need and pressure that this is imposing on the procurement organization. To add a few more examples to that, we’ve been polling CPOs over the course of the last year and a half over the topics of main concern for them as procurement leaders. And up to about the end of 2021, it was all focused on the mix of price increases, supply chain disruption, and scarcity topics. Then in the last six months, the topic of talent and the stress in the organizations and the pressure that this environment was putting on procurement professionals became almost the top concern. Our procurement organizations have been in a bit of a firefighting mode for over a year now. The realization that this environment will continue for two or three years is no longer sustainable with the resources and the approach that existed. That is catalyzing this need for investment and the change in the operating model.

In terms of what it means practically, there are a few fundamental questions that procurement organizations have to answer better, and they have to be more prepared than many have been to date during this inflationary disruption period. For example, what is our exposure? Understanding exposure to volatility, to commodities, to different input costs, at the deeper level. Understanding supply markets and the dynamics behind suppliers. Oftentimes, we know our suppliers, but few organizations really understand what is driving the supply chains behind our suppliers. Then when distractions happen, a lot of that can be attributed to second- and third-degree effects that we now have to understand and oftentimes help suppliers mitigate through collaboration and much closer involvement in how we work together.

Oftentimes, that was an afterthought for many procurement organizations. Now it may be the primary way in which we create value. So there are a few fundamental questions that procurement needs step up and mobilize for. There are a few gaps, I think, that highlight where investments are needed. One is talent, and that means redesigning your organization where you can be more strategic. You have the resources to look at supply markets in a much deeper way. For example, with clients that means we are rebuilding the so-called center of excellence. That oftentimes has been limited to pretty narrow topics. Now this need to closely understand a much broader set of suppliers and supplier markets means you need to put new resources there—you need to get your talent. And it highlights the need for technology. We face the reality that investments in technology and procurement have been lagging behind other functions for quite some time because you need both—investments and technology—to drive the effectiveness of procurement, giving better insight into your category managers.

For example, how do we track all the different indexes that matter for my category of market news and supplier disruption news? Companies investing in market intelligence platforms, in much better “should cost” modeling, and putting all of that in front of category management. Also, in efficiency, in a world where a lot of your contracts are no longer based on any kind of fixed pricing, it’s all indexed. We’re having many conversations with clients about how the simple fact of issuing a purchase order now requires you to go through a whole host of indexes, and update a whole host of assumptions, just to get to the ability to issue a purchase order. So how do we automate that kind of functionality?

Craig Reed: Just to add one thing from my discussion earlier: how you alleviate some of the pressure from the day-to-day environment by leveraging technology is essential in that process. Traditionally, you had everything that was fundamentally a part of your ERP [enterprise resource planning] system, but now you have a lot of single-source best-in-breed technologies that allow you to leverage more, differently, [and are] an opportunity to drive value. This kind of in-the-end scope becomes so important because that’s what’s being impacted, and leveraging technology, not just for you, but across your entire supply base and supply chain, is significantly important.

Marta Mussacaleca: Craig, in that example, you are highlighting the key piece around the cross-functional integration. To take it a bit further, what I’m also seeing is a very innovative way of tackling organizational design. Craig, you alluded to this in your own organization as well, which is how do we think about an organizational design that structurally ties procurement closer to these main allies in finance and the business of operations or manufacturing? Seeing dotted lines, seeing straight lines and, importantly, also seeing a lot of inviting talent from these adjacent functions into procurement to really enrich the way sourcing is done with this cross-functional margin preservation view on it.

Daphne Luchtenberg: Marta, that’s a perfect segue to my next question. As you think of the role of the CPO, how do you think the current context will shape what we need CPOs to do going forward? Craig, I’d love to hear your thoughts on that.

Craig Reed: The role of the CPO is one that’s interesting. The function also is interesting. It’s one of the few places in the company where you get end-to-end visibility of everything that’s happening across all functions. And then you also get a chance to see what’s happening across all of the operations. Then you’re also seeing what’s happening externally. Being able to bring those insights back into your company is key. With the volatility, the challenges, and the unpredictability of what’s currently taking place, it’s easy for a decision we made two years ago to not be the right decision today. Being able to provide those insights is important. Also, the role of procurement, I’ve always stated, is really about being able to bring all these of organizations together so that you can run faster with more agility and flexibility.

Many times, we think about what that means in our world, but it really means bringing the suppliers into that conversation a lot more than we have in the past—providing a lot more information than we have in the past so that we can drive better solutions in this highly constrained environment that we’re working in today. And being able to balance and work that way going forward, it’s going to be significantly important for us, especially over the next 12 to 24 months. It means making sure that, as a CPO and as a functional leader, you’re looking at the business holistically. It isn’t just about costs. It’s about how we drive the main aspects of what’s important for the financials—this is on the balance sheet, and on the P&L [profit and loss], and is focused on making sure that you’re an integral part of driving the success of the organization. Sometimes that means looking at the world fundamentally differently.

Sometimes we’re so focused on productivity and cost reduction that we miss that if you spent a little bit more here, from a total cost standpoint, it’s going to provide a much more significant benefit for the organization.

Roman Belotserkovskiy: I completely agree with everything Craig just said about the significance of the role. I think reframing the role of CPO from a guardian of part of company cost—moving from, “My mission is to keep the lights on” to “How do I really help the enterprise succeed, grow, and innovate?”—I think that is the main thing that the current environment is highlighting. And while that may have been a reality for some industries, I think now the opportunity exists for every CPO to say, “Hey, I can play a much larger role in enterprise success, and that means I need to take a much broader view of the value I can add to the function. I see the whole value chain; I see the whole company. How do I bring those insights to everybody across the organization and enable them to be more effective?” That is the unique sort of step of opportunity in front of procurement leaders today.

Daphne Luchtenberg: Helping the enterprise succeed, grow, and innovate. I love that. Marta, final thoughts from you?

Marta Mussacaleca: The importance of talent: the real asset that procurement has is talent. You’re not operating equipment. Investing in that talent, fostering the talent further upstream—working with colleges, working with [universities], and working in cross-functional training of your talent—is what is required to maintain procurement as the core business strategic function that it needs to be to continue staying ahead—not just meeting and managing—but staying ahead of the challenges in our context.

Daphne Luchtenberg: The stage is set for procurement leaders to become fully fledged strategic partners to the CEO, the CFO, and the COO. They can expand from being the guardians of a portion of enterprise cost and help lead cross-functional teams that can navigate today’s volatility while focusing on long-term value creation. Thank you all for the inspiring conversation today and for helping to bring clarity to our listeners at a time of growing uncertainty.

You’ve been listening to McKinsey Talks Operations with me, Daphne Luchtenberg. If you like what you’ve heard, subscribe to our show on Apple Podcasts, Spotify, or wherever you listen. We’ll be back with a brand-new episode in a couple of weeks.