Value-based procurement principles have roots in the healthcare industry. There is growing interest in adapting these principles in other industries as strategic procurement becomes imperative.-By BETTY ARMSTRONG

Strategic procurement is an imperative, a fact brought home during the supply disruptions due to the pandemic, natural disasters, and political events over the last few years. Today's well-designed procurement strategies contribute to business competitiveness, environmental sustainability, social justice, a diverse and sustainable supply chain, and the bottom line. Procurement already generates value in many ways, but to create the most value, the organization-supplier relationship will need to change. Value-based procurement is a strategy in which purchases are evaluated based on factors beyond price, such as evolving technologies and long-term value. It is an approach in which a maximum return on the investment in the supply chain is also achieved by flipping the relationship between key suppliers and the buyer.

Moving Beyond Price and Availability

Traditional procurement practices focus primarily on factors like price, availability, and quality as defined by the buyer. The organization’s perspective is the primary driver in the organization’s relationship with key suppliers. The purchasing contract is assigned if a supplier or vendor has the lowest price and meets other requirements. In value-based procurement, a broader perspective than price is considered, because the price is only one part of the picture. Organizations need suppliers who bring innovations to them rather than buyers issuing requirements. Value-based procurement was originally adopted in the healthcare industry, because the traditional procurement system’s focus on cost-effectiveness can “lead to false economies when considerations such as actual performance, operating costs, restrictions on healthcare teams, lost time and pollution are factored in.”

The introduction of supplier diversity could be considered an early start on moving towards value-based procurement. Price is a factor, but not the only one. Other considerations include the innovation that diversity brings the organization and potential capacity-building opportunities that will benefit communities, both of which can increase the bottom line. ESG is also a value-based principle in that considering environmental and social elements in procurement’s decision-making influences value. What is the value of protecting the environment, communities, and people through collaborative value-based procurement? Notice that considering supplier diversity and ESG principles in procurement processes means that the impacts on the organization, supplier, environment, and society may become value factors along with the price.

Adapting to a New Business Environment

Value-based procurement is a concept that Michael Porter and Elizabeth Olmsted Teisberg inspired in the early 2000s. Their research focused on designing a financially sustainable model for the U.S. healthcare system by focusing on the value created for patients and the benefits patients received concerning the total cost of care. Their model is presented in the book Redefining Health Care: Creating Value-Based Competition on Results. Traditional procurement focused on price is not a good model for today’s business environment. A PwC survey asked CEOs, “If your company continues running on its current path, for how long do you think your business will be economically viable?” In response, 39% said 10 years or less. When asked about the factors most likely to impact industry profitability over the next ten years, 40% said transitioning to new energy sources and supply chain disruption were the challenges. Five megatrends are changing the business environment: technological disruption, climate change, demographic shifts, social instability, and a fracturing world. Procurement has taken a seat at the table because of its importance in business sustainability in the uncertain environment, and value-based procurement is a better model than the lowest-price model.

Over time, procurement has moved from purchasing and sourcing to supply chain management, with relationship building coming into play. However, costs incurred by the organization remained a primary driver of decisions. One of the challenges supplier diversity leaders have contended with is convincing internal buyers that considering smaller and newer companies owned by diverse people brings a wealth of benefits, like innovation and agility. Still, there is a stubborn resistance to thinking in new terms about price. In the new approach to procurement, value achievement for the buyer and suppliers in the supply chain is considered for strategic reasons.

A procurement strategy based on the value based procurement perspective is encompassing. It considers things such as the supply environment, the organizational structure, supplier management, supplier relationships, resource availability, reputation, culture, and the ability to adapt. It is important to recognize that price is still a factor, but in value based procurement, the cost improvements are accompanied by other benefits creating value. This approach will require a deeper commitment from suppliers offering critical materials and goods or services. There is joint planning, review meetings, agility in accommodating changes, buyer and supplier cost management, and a communication process.

Flipping the Supplier-Buyer Relationship

The value-based procurement model flips marketing with suppliers, in that the buyer develops sales pitches to motivate suppliers to do business with the company, rather than suppliers pitching their business case based on specifications issued. Customer (corporate) value is measured in image improvements, technical developments, marketing intelligence, increased and stable revenue, risk reduction, knowledge transfer, and trustworthiness. The supplier does accept some risks, such as high commitment, more time investment, increased dependency on the buyer, and potentially more financial investment. “…capturing value relies on making connections between internal needs, firm strategy, and suppliers to achieve value.” Procurement management requires a deep understanding of supplier markets regarding capabilities and needs. The firm strategy will also include identifying the type of innovation desired for the market, technology developments, partnership roles, and creating value for customers.

It is suggested that the value based procurement approach is a good strategy when procurement wants to consider broader goals, such as environmental sustainability and a business environment in constant change. Getting a workable price remains important, but more is needed in many situations, like when unable to get the product when needed to continue doing business. This is not a theoretical value approach. An evidence-based approach is adopted, and this can lead to the development of required products and services through supplier partnerships. Suppliers do not push their products on customers. They use buyer-articulated pain points as “demand-market pull” to drive R&D. Moving towards this approach also means a new perspective is adopted in which suppliers and customers both win or lose together, and suppliers initiate shared risk and rewards agreements.

Moving to the Next Level

Value-based procurement is more complex than selecting suppliers based on price and quality. It remains in its initial stages of adoption in the healthcare industry and still needs adapting to other industries. However, it is a model that takes buyer and supplier relationships to the next level for the good of people, the environment, diversity and inclusion, and communities.