Process Definition

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ADVISORY

Process definition and improvement Pärnu Finance Conference 17 April 2008 KPMG

Objective of presentation

l The objective of the presentation is to highlight the importance of managing a company according to

processes and to give you an overview of process development and analysis, using also examples from a real case (procurement process), in order for you to utilize these lessons when developing the operations of your own company.

l CFOs usually have a key role in process definition and development projects because the financial

aspects are a key driver for improving processes.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Contents

Background Description of a procurement process and project example What to analyze and measure

defining KPI s

Lessons learned and summary

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Processes need to defined so that they support the company in achieving its strategy and vision Vision = Long-term overall target state

Vision

Strategy

Strategy = Short-to medium-term focus areas and actions to reach the vision

Organization

Inbound logistics

Operations

Outbound

logistics Processes

Marketing and sales

Services

Support processes l Processes and organization need to be aligned with the overall vision and strategy. l When the company is managed based on the processes, the personnel understands better its role

in the value chain and how it contributes to the value creation, and the organization s objectives are aligned with the customer value proposition. © 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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All processes have the same generic, interrelated objectives l Generic objectives for all processes are l Quality; as few errors and corrections as possible and as viewed by customer l Speed; (typically) as fast as possible without compromising other objectives l Cost effectiveness, margin enhancement l Adequate controls and risk treatment to mitigate the process risks l These are also the things that should be measured and analyzed l Usually, there is not a trade-off between the objectives but they support one another; when a

process has been automated as far as possible, it is error-free, fast, cost effective and also has enough controls if these have been planned and implemented in the system.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Defining processes: the SIPOC method

l A business process can be defined as "a chain of logical connected, repetitive activities that utilizes

the organization's resources to refine an object for the purpose of achieving specified and measurable results or products for internal or external customers.

l The generally used SIPOC method for process definition consists of five elements:

The suppliers are the individuals, departments, or organizations that provide the materials, information, or resources that are worked on in the process being analyzed.

l Supplier

The inputs are the information or materials provided by the suppliers. Inputs are transformed, consumed, or otherwise used by the process.

l Inputs

The process is the steps or tasks that transform the inputs into outputs: the final products or services.

l Process

l Outputs

The outputs are the products or services that result from the process.

The customers are the individuals, departments, or organizations that receive the outputs, the products or services, generated by the process.

l Customers

Supplier

Inputs

Process

Outputs

Customer

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Describing processes: standardized methodology must be utilized

SSC other teams

Accounts Payable : Invoices Handling

Example of (part of) a process flowchart

Invoices Payment Yes

SSC Accounts Payable Team

Yes

Invoice to be paid

No

10a. Block invoice for payment with permanent payment block

Does the vendor exist in SAP?

No

Create vendor in SAP

10b. Put a payment block B on invoice until invoice approved

11. Send invoices for electronic approval

13a. Send copy of invoice to GL team

Periodize

Yes

Company / Unit

No

13b. Archive invoices

12. Certify / approve according to the approval rules

Systems

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Paper SAP

SAP

SAP

SAP

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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An example of the importance of processes: challenges preventing Company X from realizing potential value from procurement and improvement approaches Profit improvement; identifying bottom line savings

Process and control inhibitors

Relationship based sourcing strategy

Inconsistent processes Excessive manual intervention Redundant activities Inappropriate performance measures Inadequate controls

Procurement risk management Supply continuity

Su pp li er eva lu atio n a nd sel ecti on

So urci ng Strate gy

C on rt a ct wi th su pp li er

E val uate spen d requ ri eme nts

Procurement cycle Val ue Performance Quality

Mana ge Proc ess

Regulatory and compliance

Rece vi e Goo ds & S ervi ces

Ma n i tain Pu rcha se L edg er

Technology Inhibitors

Price risk

P la n and ma ke p urcha se

Ma ke P aym ent

Pro cess In voi ces

Organizational Inhibitors

Intellectual property

Undefined roles & responsibilities Insufficient training Skills or experience gap

Multiple legacy systems Lack of integration

Sustainability Fraud

Capability enhancement; building your capability to help deliver long term value from your supply base Organization and people Process Technology © 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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A systematic and rigorous approach is necessary to achieve concrete results in process development projects example in Company X l

Steering Group oversees the project progress, decides on the focus areas of the work, approves budgets and deliverables

l

Project Group is responsible for the interviews and data collection, as well as performing the analysis and preparing for and documenting the workshops

l

Reference Group provides input to the current state analysis and target state definition

l

Workshop Group discusses the findings of the review and analysis and defines the target state

Monitor Implement Design Insight Plan

Month 1

Month 2

Month 3

Month 4

Steering Group Interviewees / Reference Group

l l

NN, CFO NN, Quality & Process development

l

NN Partner, KPMG Advisory

l

NN. Project manager NN, Manager, KPMG Advisory NN, Analyst, KPMG Advisory

Depending on the process, if e.g. procurement process l l l l

Procurement manager Buyers Accounts Payable and Cash Management persons Relevant line manager

Project Group

l l

Workshop Group © 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Contents

Background Description of a procurement process and project example What to analyze and measure

defining KPI s

Lessons learned and summary

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Procurement encompasses two sub-processes: Sourcing and Purchasing development objectives in Company X An optimal multi-tier supply base structure is designed

Best suppliers are selected, optimizing both quality and price Supplier evaluation and selection

Sourcing Strategy

People are well trained and aware of their duties, specialists give centralized support

Contract with supplier

Evaluate sp end requirements

Value Performance Quality

Manage Process

A total supply chain vision is adopted towards management of total cost and value

Plan and make purchase

Sourcing Purchasing

Receive Goods & Services

Maintain Purchase Ledger

Process Invoices

Make Payment

A/P is processed as automatically as possible

Purchases and receiving are performed as automatically as possible No unauthorized or incorrect purchases are made

No possibility for fraud

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Purchase to Pay process overview and sub-process description in Company X

Purchase to Pay (Company X scope) Contract with supplier

Plan and Make Purchase

Receive Goods & Services

Process Invoices

Make Payment

Maintain Purchase Ledger

Manage Process

Purchase to Pa y Sub-Pr ocess

Description

Contract with Supplier

Negotiating with short-listed suppliers and making a contract based on the defined supplier selection criteria

Plan and Make Purchase

Identifying a purchasing need, raising a requisition and specification of requirements, obtaining appropriate approvals, selecting the supplier and making a purchase

Receive Goods & Services

Receiving of goods purchased or services rendered, routing of paperwork to designated signatory and managing exceptions

Process Invoices

Receiving and processing invoices, checking against authorizations, solving discrepancies with unmatched invoices and authorizing invoices in preparation for payment

Make Payment

Prepare and confirm payments, make payments, handle requests for special payments, distribute payments and file documentation

Maintain Purchase Le dger

Set up or amend supplier information, maintain information tables, maintain security attributes

Manage Process

Define, maintain and communicate the procurement process and respective policies; define measures for following up of the process performance; report and manage the performance

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Purchase to Pay leading practices comparison in Company X (1/2)

Sub-Process

Organization & people

Process and controls

Systems and technology

Contract with Supplier

Only authori zed personnel makes contracts with suppliers.

Supplier selection process has been defined and documented.

Supplier selection is supported by the purchasing system.

Supplier evaluation criteria have been defined and documented. Supplier contract terms and templates are standardized.

Plan and Make Purchase

Only authori zed personnel makes purchases. Specialist buyers are responsible for defined purchasing categories.

Receive Goods & Services

Only authori zed personnel receives goods.

Procurement planning is made in the beginning of the project and regularly updated.

Procurement planning is supported by the purchasing system.

Purchases are made primarily from preferred suppliers, based on framework agreements.

Goods are received in a secure location. Goods are inspected and any necessary complaints made to the supplier in a timely manner. Complaint process is followed up to ensure resolution.

Purchase orders are made using standard tools, e.g. E-catalogues. Authori zations to make purchase orders are restricted by the ordering system. Goods receipt is matched to the purchase order in the system. System supports the follow-up of credit notes by facilitating the blocking of invoices.

Practice implemented by Company X Practice partly implemented by Company X Practice not currently implemented by Company X © 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Purchase to Pay leading practices comparison in Company X (2/2)

Sub-Process

Organization & people

Process and controls

Systems and technology

Process Invoices

Invoice processing is centralized to a shared service center.

Invoices are separately reviewed and approved only in case there are deviations between purchase order and goods receipt.

Invoices are matched to the purchase orders and goods receipts in the system. For invoice re view and approval, electronic circulation is used. Review and approval rights are enforced by the system. E-invoicing is used to eliminate the need to manually input invoice data in the systems.

Make Payment

Two persons’approval is needed for sending the payment file to the bank.

Payment process is fully electronic. Payments are not made before due date to optimize working capital.

Making payments is centralized to a shared service center.

Maintain Purchase Ledger

The authority to create or maintain supplier master data is restricted to persons who do not record invoices or make payments.

Inactive suppliers are regularly cleaned up from the supplier register.

Manage Process

A defined procurement process owner is responsible for the development of the process.

Adequate policies, instructions and authorizations have been defined and documented.

A common supplier master file is used by purchasing and A/P functions.

Process performance is measured and reported using defined KPIs. © 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Key findings and risks in Company X Purchase to Pay process

Sub-Pr ocess

Key findings

Related risks

Contract with Supplier

Supplier selection process is not very systematic, principles for tendering of suppliers have not been documented.

Not necessarily the best supplier (regarding price, quality or delivery accuracy) is selected.

Plan and Make Purchase

Purchasing planning is often made on too high a level, creating need for urgent purchases and making purchasing follow-up difficult. Purchasing authorizations are not restricted.

The price can be higher and the supplier less reliable than if the purchase had been planned and made early enough. Inappropriate / unnecessary / fraudulent purchases can be made.

Receive Goods & Services

There is no defined procedure for receiving goods on the construction site. Goods inspection can be done months after the receipt of the goods. Filing of complaints and follow-up of credit notes is not systematic, neither is the follow-up of late deliveries or late invoices. No 3-way match (matching the purchase order, goods receipt and invoice).

It is possible that the goods (or services) do not meet the order criteria (regarding quality or quantity) or e ven completely incorrect materials are accepted. Some credit notes can be missed if their follow-up is not systematic. Goods can be damaged or lost if they are inappropriately stored after receipt.

Process Invoices

Invoice processing is fairly automatic but there is no 3-way match.

Without 3-way match, it is possible to approve invoices for which there is no corresponding purchase order and/or goods receipt.

Make Payment

Payment process is fairly automatic, the risks are related to the wide authorizations to create payment files and the lack of payment approval before sending the file to the bank.

Inappropriate / erroneous / fraudulent payments can be made.

Maintain Purchase Ledger

Suppliers are created based on invoice data without separate review or approval. Inactive suppliers are never cleaned up from the invoice register. Same persons in the A/P function create and modify supplier master data, record invoices and create payment files.

Inappropriate / erroneous / fraudulent supplier master data can be created.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Summary of the review phase in Company X

l The review of Company X s Purchase to Pay process initially focused more on the control aspect

than on the generally efficiency or the performance of the process.

Ø However, often these are linked: a well-controlled process is also efficient as the controls are

automated and responsibilities and authorizations clear.

l From the control perspective, several weaknesses were identified, especially related to the

Goods Receipt and Ledger Maintenance phases of the process.

Ø Control over Goods Receipt, as well as over the whole process, could be significantly

improved if 3-way match was possible.

l In the first phases of the process, Contract with Supplier and Plan & Make Purchase, there are

few real controls; the performance and control of the process depend upon the competence and diligence of the personnel, especially of the Project Managers. Ø Process could be improved by clarifying the principles for supplier tendering and selection,

stronger management supervision and wider utilization of the existing purchasing systems.

l Invoice Processing and Payment phases of the process are automated and reasonably well-

controlled, though there are some issues regarding the wide authorizations.

l Better procurement planning would be a key thing to generally improve the process.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Contents

Background Description of a procurement process and project example What to analyze and measure

defining KPI s

Lessons learned and summary

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Key principles for defining Key Performance Indicators (1/2)

Selection of the indicators l The set of indicators chosen should be: l Relevant to the organization s objectives l Balanced to measure both strategic and operational performance (financial, non-financial) l Clearly defined to confirm consistent collection l Easy to understand and use l Comparable l Unambiguous so that it is clear what constitutes good performance l Verifiable and statistically valid l Cost effective to collect l Responsive to clearly reflect changes in performance l Timely so that the information is not out of date

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Key principles for defining Key Performance Indicators (2/2)

Setting the target levels l Ambitious but realistic l Based on benchmarking information, better practice guidelines and reviews l Taking into account resource capacity and capability as well as other possible constraints l Kept up to date to meet changing circumstances l Reflected in the organizations financial and service planning cycles

Reporting and follow-up l Trade-off between the levels of accuracy of info and the early availability of information l Not to be dictated by existing process and procedure, even though existing processes should be

used where possible

l Exception or issues based reporting allowing for a quality debate l Materiality threshold for information to be presented at management level l More analysis on trends to give greater insight and meaning

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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KPI s must be exactly defined in order to facilitate proper analysis and communication -Example of a definition matrix (1/2)

KPI Definitions matrix KPI Reference – Name

Procurement Systems Availability

Business Objective

Maintain high procurement systems availability (20 percent of bonus measure for 2004)

KPI Description

Procurement systems availability

KPI Measurement and Calculation

Maximum availability of systems with recorded incident outages deducted for each sub-system. System availability raw figures are aggregated.

KPI Units of Measure

Percent Uptime of aggregated systems availability

KPI Type

Leading

KPI Dimensions and Scope

Frequency

Unit

Region

Product

Monthly

Business Unit

Baltic

XYZ

Table continues on next page

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KPI s must be exactly defined in order to facilitate proper analysis and communication -Example of a definition matrix (2/2)

Table continued from previous page

KPI Benchmark / Target

99.86 percent Red

Amber

Green

<99.7 percent

<99.8 percent

>99.8 percent

Target Thresholds

KPI Owner

XXX, Head of Service Delivery

Data Owner

XXX, YX Service Line Management

Data Supply

Data sourced from Service Management Daily Incident report and SMART. Data to be supplied by AAA via email to BBB by Working Day X.

Data Integrity

Data checked in detail by Service Line Management team. Description of the current degree of accuracy and reliability of the data used for the KPI.

Actions

Available from existing reports/activities

Comments

XXX

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Example: procurement process KPIs for Company X

Total cost of the process "select suppliers and develop/maintain contracts" per 1 MEUR purchases/revenue

Number of FTEs for the process "develop sourcing strategies" per 1 MEUR purchases/revenue

Number of FTEs for the procurement cycle per 1 MEUR purchases Total cost of the procurement cycle per 1 MEUR purchases

Contract with supplier

Value Performance Quality

Manage Process

Number of FTEs for the process "order materials/services" per 1 MEUR purchases/revenue.

Plan and make purchase

Receive Goods & Services

Maintain Purchase Ledger

AP # FTEs

Percentage of purchase orders approved electronically.

Supplier e valuation and se lection

Sourcing Stra tegy Evaluate spend require ments

AP Systems Cost

Make Pa yment

Percentage of invoice line items paid on time. Percentage of discounts available that are taken.

Cycle time in hours to place purchase order.

Process Invoices

Percentage of invoices matched & processed electronically, without separate approval.

Cycle time in days from receipt of invoice until payment is transmitted.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Example KPIs for other main processes

Inbound logistics lTotal

cost of "Supply Chain Planning" process (% of revenue)

lTotal

cost / personnel cost / systems cost of the process "plan inbound material flow" per 1 MEUR revenue.

l(see

Outbound logistics

Operations

also the examples on the previous page)

lAnnual

rate

inventory turn

lScrap and

rework costs as a percent of sales

lFinished

product, first pass quality yield

lManufacturing

time in hours

lOn-time

cycle

delivery rate

lLabor

turnover rate as a percentage of work force

lTotal

cost of the Manufacturing process per 1 MEUR revenue

lTotal

cost of logistics per 1 MEUR of revenue.

lTotal

cost / personnel cost / systems cost of the process "operate warehousing" per 1 MEUR revenue.

lTotal

cost / personnel cost / systems cost of the process "operate outbound transportation" per 1 MEUR revenue.

lNumber

of FTEs in the process "operate outbound transportation" per 1 MEUR revenue.

lNumber

of annual sales orders filled per "operate warehousing" FTE.

lCustomer

order cycle time in days.

Marketing and sales lTotal

sales

lSales

expense/revenue (%)

lSales

per channel

lTotal

sales process cost

lTotal

process cost per channel

lTotal l#

# sales FTEs

FTEs per channel

lAvg.

cost per sales employee

lAvg.

cost per sales employee, per channel

Services

lTotal

cost of service process

lTotal

service employee costs

lTotal

FTE-s

# of service

lCycle

time for service management (e.g., # hours from issue reported to resolution)

lCustomer

retention rate.

lSystems

Cost "Sales" / "Channel Management"

lSales

forecast accuracy

lCycle

time in for sales (e.g., # days / hours from initial inquiry to closing the sale)

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Contents

Background Description of a procurement process and project example What to analyze and measure

defining KPI s

Lessons learned and summary

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Lessons learned from process definition and improvement projects

l Top management involvement and commitment is essential. Getting the buy-in takes time and

usually several workshops are needed.

l When defining processes, people easily think only functionally (e.g. sales function = sales process,

procurement function = procurement process) but the whole purpose of defining processes is to think of the cross-functional flows.

l The truth is in the details

to really understand the current state of a process, it needs to be analyzed on a sufficiently detailed level.

l Even if a process is analyzed and developed only from one perspective, e.g. from the control

perspective, typically the improvements cover also the other process objectives, i.e. make the process faster, less error-prone, and more cost effective.

l Process improvements often require changes in the IT systems and thus take time to implement, but

it is always better to aim at automated processes. However, the process must be quite ready before automating it.

l Each process needs to have an owner, who takes ongoing responsibility for maintaining and

developing the process. Shared responsibility is no one's responsibility.

l Process responsibilities also need to be aligned with the existing responsibilities, e.g. functional and

business responsibilities.

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Summary

l The best way of delivering the customer value proposition and to achieve internal effectiveness is to

manage a business according to processes, as opposed to only according to organizational functions.

l The process perspective focuses on co-operation, integration and the end-results of doing something.

This way different parties understand better how their work affects the whole, what they need to do, when and why.

l Developing processes must be based on a thorough understanding of what drives the value (cash

flows) of the company.

l The process perspective enhances internal co-operation between different functions/departments

and people and makes better use of the company s resources.

l Thinking about the entire process makes optimization easier and helps avoid the risk that certain

issues fall between the chairs .

l The main objectives when defining and developing processes are related to: quality (e.g. error-free,

customer perceived), value (e.g. cost efficiency, margin enhancement), time (e.g. speed) and risk (e.g. sufficient but not excessive risk treatment and control).

l Process objectives and metrics must be prioritized based on their strategic and financial importance

(which change over time).

l Process development and analysis is a modern and effective approach for running any kind of

business (or support functions).

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

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Contact information

THANK YOU !

Jan Montell Partner Advisory Mannerheimintie 20 B PO Box 1037 00101 Helsinki, Finland

© 2008 KPMG Oy Ab, a Finnish limited liability company and a member firm o f the KPMG ne two rk of independ ent memb er fi rms affiliated with KPMG In ternational, a Swiss cooperative. All rights reserved. Printed in Finland.

Tel +3 58 (0)20 76 0 383 1 Mobile +3 58 (0)40 592 4419 [email protected]

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