Utility procurement: Ready to meet new market challenges

The life of a utility procurement professional has been difficult for a long time. As one utility chief procurement officer (CPO) told us, “We have one of the toughest jobs in the industry.” Utilities’ ambitious capital expansion plans drove double-digit growth in spending and forced procurement functions to find, purchase, and deliver at competitive rates an ever-expanding variety of materials, parts, and services. Many functions struggled to meet the demands because their organizations did not make additional investments to build new procurement capabilities and to counteract high rates of attrition.

The COVID-19 pandemic, inflation, macroeconomic uncertainty, and geopolitical tensions have added supply shocks to the long list of challenges, making the procurement function’s tough job even more demanding. A sampling of data gives a sense of the impact: earlier this year, active container-shipping supply, a proxy for supply chain agility, reached its lowest level globally since 2019. Over the past three years, private-sector wages rose two times faster than during the prior ten years. And prices of commodities, such as energy and metals, remain at sustained high levels compared with 2010 baseline levels.

To keep up with this faster-paced and more demanding environment, procurement teams need better demand transparency, capabilities, and tools, while CPOs need to help their CEOs and CFOs rethink procurement’s role in the future success of their organizations.

McKinsey’s 2022 CPO Survey reveals that North American utilities are generally not well-prepared to handle the current strains. The annual survey applies the six dimensions of the Global Procurement Excellence (GPE 360) framework, covering the performance and operating model of procurement functions.¹For the 2022 study, we collected more than 17 data points by interviewing 12 top procurement leaders of North American utilities, supplemented with industry-specific data points from our GPE 360 surveys conducted over the past 12 months.

In the more than ten years since we introduced the framework, the energy and utility sector’s procure­ment maturity has, on average, lagged behind industries such as automotive and consumer. Indeed, the utility industry’s average procurement maturity score of approximately 2.0 in the 2022 CPO Survey indicates relatively low maturity (Exhibit 1). However, procurement performance across North American utilities is far from homogenous. A cluster of utilities has a higher average score, showing the potential for breakout performance. The top performers are set apart by a bias for action and an ambition to make procurement a driving force in the organization. Many of them have successfully led company-wide transformation efforts and have elevated their roles well beyond order taking.

1

Although the survey identifies many competing priorities, several recurring themes dominate the responses and reflect the challenges of the current environment (Exhibit 2).

2

In each of these priority areas, North American utilities are changing their practices to adapt to emerging issues. Based on the experience of leading utilities around the world, we have identified a set of global best practices that North American CPOs can apply to raise their function’s performance to world-class standards in each topic. Mature organi­zations as well as those that are defining their transformation journey can benefit from the insights.

Strengthen business partnering to manage risk, drive spec innovation, and improve demand planning

For utility procurement organizations, being “on time” and “on the money” have been paramount goals. “We are there to get the business what they need—by the time they need it and at a competitive price,” explained one utility CPO. Organizations have traditionally bought many categories on short notice—30 to 45 days’ notice was more than enough time to deliver 90 percent of the materials needed by a typical utility.

This is no longer true today. Lead times for some “bread and butter” materials and parts have at least doubled. United States–based producers of transformers, meters, metal structures, and regulators, for example, are capacity constrained and unable to serve all the demand. “What used to be a four- to six-week lead time for steel is now 24 weeks,” a CPO told us. International supply has its own risks arising from qualification challenges and logistic delays.

The current crisis exposed the Achilles’ heel of many utilities: demand planning (see sidebar “CPO experience: How one utility overcame a demand-planning gap”). Although visibility into future spending is essential for a high-quality sourcing plan, many utilities conduct detailed capital planning that covers only a rolling six weeks or an even shorter time frame. Because procurement teams have insufficient visibility, they struggle to meet service-level requirements and receive poor performance reviews that further exhaust team resources, damage morale, and drive attrition.

The complexity of specifications is a long-standing and persistent problem. Many utility engineering organizations take pride in their bespoke equipment designs, but these take longer to produce and require manufacturing-line adjustments. Five years ago, equipment producers were willing to absorb those inefficiencies. Today, utilities that deviate from a producer’s recommended specifications are likely to see their bespoke designs dropped from the production plan or receive a request for a substantial price increase.

To manage risks in the short term, procurement teams need reliable communication with the business units and the finance function. Supply chain leaders can focus on creating a robust stakeholder map and a regular cadence of CPO updates for the entire senior-leadership team. Improved communication serves a dual purpose: building trust during the initial period of firefighting and creating a solid platform for the longer term.

Even with better communication, the complexity of today’s planning cycle requires CPOs to take the more transformative approach of challenging the organization’s existing processes and cultural norms. A sustainable long-term solution has three components, each of which will be aspirational to many utilities:

1. Increase the level of detail and horizon of demand planning. To achieve this, one successful utility set up a demand-planning task force—a cross-functional team co-led by the supply chain and the business. The goal of the effort was to convert the existing capital and maintenance plans into a clear set of category-specific statements of work (SOWs), gradually expanding the planning cycle from less than one month to more than 12 months. With the right details in hand, the supply chain team can get ahead of the curve and launch sourcing efforts earlier.
2. Add supply chain intelligence as an input into capital planning. Materials and labor availability, supplier capacity, input cost volatility, and lead times are among the must-have inputs to track. Expanding procurement’s role in capital planning requires a paradigm shift for many utilities. While procurement’s role in planning is well established in more mature industries, such as manufacturing and telecom, an average North American utility does not recognize the strategic importance of procurement function and hence does not invite its leaders to the decision-making table. Chang­ing the paradigm requires a cultural shift that can be role-modeled from top to bottom, starting with the most senior leaders.

3. Rationalize and reduce the complexity of specifications. Successful despeccing relies on two enablers:

   • building trust-based relationships with the business to create a forum for effective and well-informed cross-functional discussions
   • developing reliable feedback loops with the vendors to allow the parties to communicate which equipment features can be standardized, how costs can be rationalized without jeopar­dizing functionality, and what the resulting benefits for lead times and availability may be

   Although most complexity reduction efforts will focus on equipment and parts, utilities can use this lever effectively in services as well. At one utility, the procurement function, jointly with the business, simplified and reduced the number of units in line construction by 50 percent. The simplification allowed the utility to streamline supplier pricing and better align monetary reward with the work done in the field.

Because capital and operational plans are increas­ingly threatened, business partners are willing to collaborate on such efforts more than ever. In the words of one CPO, “Let’s not waste the crisis.”

Manage categories and supplier relationships to promote resilience

For at least the past ten years, companies have used vendor consolidation to successfully drive supply chain efficiencies. In the utility industry, leaders have historically targeted two or three vendors to provide services representing up to 90 percent of spending in each category. Given that supply chain disruptions show no signs of abating, many organizations should start to consider changing their category strategies by shifting from consolidation to greater diversification (see sidebar “CPO experience: Diversification for supply chain resilience”).

As one CPO described it, “We doubled our number of suppliers for critical parts, expanding geographically and reserving capacity as far in advance as possible.”

A shift toward diversification, while intuitive in the current environment, needs to be well considered. Categories have not been equally affected by supply chain and inflation constraints. Many CPOs report receiving price escalation requests that, when probed, are not justified. The solution is to take a differentiated approach.

To understand which categories and suppliers are truly affected, start by assessing supply risk across two dimensions: probability of risk versus strategic importance at the category level (Exhibit 3). Considering that utilities have, on average, more than 50 categories, some categories will indeed require strong interventions; however, many likely won’t.

3

When introducing a category risk assessment, compa­nies must avoid several pitfalls. We have distilled several recommendations to ensure that companies achieve the goals of the risk assessment. These are not common practices today:

• Establish senior-procurement-leadership oversight of the assessment to ensure a standard approach and equal level of rigor across categories. The investment of leadership time is justified because the results of the effort will have long-lasting implications for the entire cost base.
• Involve business partners in assessing each category’s strategic importance. Use objective criteria to lead the discussion. If “everything is urgent,” then nothing really is.
• Conduct an independent market-driver analysis for each category to separate a true signal from the noise. Don’t accept vendors’ perspectives on market drivers as the single source of truth.

The results of the assessment provide a road map that sets out which categories and suppliers to derisk versus which to monitor or even leverage to keep companies’ operation and maintenance budgets level.

For categories in the derisk bucket, companies can proactively deploy several mitigation steps:

• Strengthen relationships with existing vendors. Improved collaboration with suppliers makes it easier to validate existing and forecast capacity and encourage frequent capacity updates. For example, one utility CPO dedicates one day a week to personal calls with the CEOs of his largest suppliers and frequently exchanges texts with the most important ones. For items with high risks or long lead times, secure future capacity. If price escalations are imminent, introduce index-based pricing or establish open-book contracts.
• Identify and onboard new vendors. Proactively screen the market for diversification oppor­tunities, both domestically and internationally. Accelerate the qualification process, including any required testing.
• Standardize service requirements, materials, and parts. Align supply availability and business requirements. For example, one utility switched from pad-mounted to pole-mounted transformers after finding that vendors could no longer supply the former. Simplify specifications to match the industry or vendor standard and consolidate specifications to match the most frequent or prevalent ones.

These strategies are not mutually exclusive and provide maximum benefit when pursued simulta­neously. Even in today’s environment, many utilities continue to rely on existing supplier relationships. Although appealing in the short term, this strategy may hurt the long-term negotiation position and, ideally, should be supported by other measures. Finally, a bias for action in the context of inflation is especially important.

Build digital and analytical capabilities to accelerate, amplify, and sustain the impact

The universe of digital solutions for procurement has exploded, with myriad point solutions and integrated vertical software. If successfully deployed, digital systems can separate leaders from followers by automating a large share of tactical work. Despite the obvious benefits, however, many utility CPOs participating in our survey are not satisfied with their past digitization efforts and have not seen the expected return on investment. “We spent 12 months implementing a new procure-to-pay system and did not see the benefits,” one CPO told us. Another CPO acknowledged that digital tools have “great functionality” but that the “complex user interface limits adoption.”

This dissatisfaction is especially evident for source-to-pay (S2P) systems and analytics.

Digital backbone and S2P. Approximately 60 percent of North American CPOs describe their S2P system as immature, and more than half admit they are not getting the expected return on their S2P digital investments (Exhibit 4). They frequently mention several issues as a root cause of unsuccessful digital S2P transformations and lagging user adoption:

• underestimating the effort required to deploy the new tech during the selection phase
• not prioritizing a high-quality user experience
• inadequate standardization of processes
• insufficient training of users

4

To counter these pitfalls, procurement organizations should holistically address the challenges by focusing on “outcomes” instead of “activities” (Exhibit 5).

5

Although launching a digital transformation is no small feat, several quick actions are no-regret moves for an organization not yet ready to pursue a full-scale transformation:

1. Ensure 100 percent adoption of e-RFx²Electronic request for X (request for proposal, request for quote). tools to automate the strategic sourcing process and allow category managers to focus on strategic activities. To increase e-RFx adoption, one utility created a real-time dashboard to track the number of log-ins and events created by each category manager or sourcing specialist. Every month, the managers or specialists with the highest number received special recognition throughout the organization.
2. Increase awareness of existing automated purchasing channels and deploy new ones jointly with strategic vendors.
3. Eliminate critical user pain points by following the voice of the customer across the procure-to-pay process. For example, one utility eliminated its top-20 procure-to-pay pain points with just a few agile sprints supported by an in-house development team. Addressing most of the pain points required only minor modifications to the existing workflows, such as adding a secondary approver for purchase requisitions or disregard­ing discrepancies between purchase orders and invoices below $1 in value.

Advanced analytics. Most interviewed CPOs see the need for substantial improvements in their data and analytics capabilities. The adoption of spend transparency tools is a step in the right direction. More than 60 percent of survey participants have already deployed one of the spend analytics platforms available in the market to create an initial level of insight.

Select players have taken this further. One US utility demonstrated that building bespoke parametric models for its largest spend categories enabled category managers to achieve favorable negotiation outcomes even in the inflationary environment (see sidebar “CPO experience: Countering price escalation requests”). Other utilities have used digital control towers to focus on compliance improve­ments and created dashboards to dynamically track the most critical commodity items and share that information across the organization.

Whether a company is in the process of building an advanced analytics team or just starting to think about bringing analytics capabilities in-house, several pieces of advice drawn from our study are relevant:

• In many cases, the easiest way to get started is to build out the analytics team as confidence grows and the return on investment becomes clear. Often, procurement leaders try to scale without having a robust business case, making it very hard for the CFO to approve the investment. Building a clear road map of use cases and associated value for the organization should help to change the perception of procurement from a “cost center” optimized for FTE (full-time equivalent) count to a “value center” that drives impact for the organization.
• The first analytics use cases should balance impact and simplicity—starting with cases that have been successfully deployed by peer organizations is a great way to build confidence. One utility asked its newly hired analytical resources to build a should-cost model for an upcoming wire and cable request for proposal. The team not only succeeded in building analytical models that directly supported the negotiation process but also managed to strengthen connections with an engineering team that got excited about the new capability.
• Reliable data are a prerequisite for successful analytics. Data aggregation and cleaning is not a one-off effort. It requires a systematic approach, including data management processes, standard notation practices, and regular data reviews.

Building a road map for the next 24 months

Maintaining focus in the current environment remains one of the biggest challenges for utility CPOs. With procurement organizations knees-deep into the firefighting, selecting those few initiatives that will move the needle can make a big difference. While our CPO Survey’s priority list is a starting point, each organization should be mindful of its distinctive­ness. To validate hypotheses for priority initiatives, answer the following questions:

1. Which initiatives will allow the procurement organization to free up the most time?
2. Which will drive the highest return on investment if sufficient resources are allocated?
3. Which will provide the greatest benefits to the business partners?

Once initiatives are selected, develop an implementation road map that sets realistic timelines with granular milestones and clear ownership. Establishing a regular review cadence and gover­nance will help to keep execution on track.

Transforming procurement for today’s unprecedented environment is not easy. But the challenges we are seeing across supply chains are, in many cases, structural and may take years to resolve. Taking transformative action is the only option. For many utility companies, immediate priorities likely include strengthening procurement–business collaboration, improving category strategies and vendor relations, and building digital and analytics capabilities for strategic actions. To achieve these objectives, the successful utility CPOs will elevate the role of the procurement function to become a true partner to CEOs, CFOs, and COOs.