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Capital Procurement: The Cornerstone of Successful Projects

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Despite the economic challenges that markets all over the globe continue to face, many industries—including basic materials, oil and gas, and utilities—have large-scale projects in the works. Over the next four years, for example, the top ten mining companies together plan to spend more than $200 billion on capital projects related to spending categories such as machinery, infrastructure, and engineering services.

Such capital projects are typically very large investments, often representing more than 10 percent of a company’s annual revenue, depending on the industry. Notably, too, external capital spending can represent 80 percent or more of a project’s total budget. Many companies have established dedicated capital-procurement functions and have put project-specific procurement teams in place. Those companies regularly update their supply strategies for important equipment and service categories and clearly define core processes such as cost escalation estimation and claims management (the process of negotiating paybacks related to changes in project plans, unexpected cost increases, or quality problems). Standard project procedures and handbooks mandate that project compliance be monitored closely. (See the sidebar “The Dos and Don’ts of Capital Procurement.”)

The Dos and Dont's of Capital Procurement

In our experience, companies with successful capital-procurement programs ensure that ten elements are in place and avoid ten common stumbling blocks.

Successful companies do the following:

  • Establish the transparency of category spending across the project portfolio.

  • Ensure the involvement of the procurement function as early as the concept phase of every project.

  • Streamline project approval processes to ensure that procurement has sufficient lead-time to secure the best possible proposals from suppliers.

  • Develop a clear profile of accountabilities and required skills for project procurement managers, especially in the case of large projects.

  • Build a dedicated team of procurement experts focused on both overall and project-specific procurement.

  • Clearly define cross-functional procurement processes as part of a project handbook.

  • Establish a total-cost-of-ownership perspective with regard to key equipment and investment decisions.

  • Track project and partner performance based on KPIs that address project performance and progress, as well as procurement effectiveness and supplier cost performance.

  • Systematically evaluate alternative contracting models and incentive schemes on the basis of project complexity and size.

  • Actively monitor compliance with procurement processes, including subcontractors that assume procurement tasks.

Successful companies don’t do the following:

  • Make unrealistic assumptions regarding addressable spending volumes. Instead, they clarify the share of committed spending volumes for every project.

  • Allow ambiguity on cross-project demand. Rather, they use standard project and equipment structures to define work packages.

  • Avoid regular interaction with key stakeholders. They interact with stakeholders using a consistent platform for the procurement and project management functions.

  • Lock in suppliers too early. Successful companies don’t let engineers and design personnel make commitments with potential suppliers prematurely, because doing so limits supply options and precludes competitive contracting.

  • Take an unfocused, overly broad approach to optimizing categories. Rather, they prioritize spending areas with short-term impact and strategic importance and ensure that sourcing strategies are fully developed and implemented systematically.

  • Put insufficient focus on the procurement performance of third parties. Successful companies ensure that procurement-related incentives are agreed upon as part of their arrangements with major project partners and contractors.

  • Overlook project-specific dynamics. Instead, they consider project timelines and constraints in cross-project approaches, such as bundling.

  • Fail to define procurement career paths and roles. Successful companies attract procurement talent by clearly defining career paths.

  • Fail to clearly calculate savings. It is better to provide clear guidelines on how value is defined and how potential savings should be specified.

  • Focus too restrictively on project delivery. Instead, successful companies review procurement strategies and timelines in light of changing project business cases (in an economic downturn, for example).

In practice, however, many companies continue to struggle to establish a consistent approach to capital procurement, and they suffer various consequences:

  • They experience poor capital-procurement performance and significant deviations from established budgets and schedules, as well as from benchmark cost levels.

  • They do not identify and manage supply-related risks early enough, and thus they suffer from increased capital expenditures and operational costs relative to initial plans—as well as frequent extensions of lead-time for critical equipment.

  • They lack a cross-project perspective, which keeps them from sharing best-practice designs, leveraging aggregate demand, and establishing partnerships with key suppliers on a global level.

  • They lack the tools needed to manage decisions effectively, track the impact of decisions across the project life cycle, and monitor the performance of procurement activities or suppliers in individual projects.

On the basis of projects that The Boston Consulting Group has worked on with clients, we have identified four building blocks of a successful capital-procurement operating model that can be applied by companies across many industries:

  • A dedicated capital-procurement strategy that considers the specifics of the supply market, the capabilities of the company, and the requirements for the successful delivery of capital projects

  • An integrated approach to value delivery and risk management in the procurement of project-related goods and services

  • A consistent organization structure as well as a clear definition of processes

  • The development and enablement of high-performing cross-functional teams

This model, when aligned properly with both internal and external stakeholders and consistently applied, can sustainably improve the performance of a company’s capital-procurement function. Companies using this model can save as much as 15 percent of a capital project’s net present value while reducing risk and ensuring that budgets and timelines are met. These building blocks are critical to establishing competitive price levels across key spending areas and ensuring that project-related supply risks are appropriately managed. (See Exhibit 1.)

exhibit