How Should You Define Procurement Success?

This question is encased in a nut that’s quite tough to crack. We hinted at the importance of defining it three years ago in our post that asked how do you define Procurement success which noted that if you consider the art of the Strategic Sourcing Process, the Category Management Process, or the Contract Management Lifecycle, you [not only] see that they all start about the same at a high-level but that a key requirement of each step is an acceptable definition of success.

This means that if you want to be successful, you need a good definition of success but what should it be?

If you ask the CFO, she will say it should be cost savings! Reduce the outflow!

If you ask the Chief Engineer, it should be the best quality and reliability money can buy!

If you ask the Production Chief, it should be rock solid supply availability.

If you ask the CMO, it should have the most unique gee-whiz features on the market for the biggest marketing splash.

If you ask the VP of Sales, it should be the product that comes with the most value-adds so they can command the greatest price.

And so on.

On SI, we have repeatedly said the definition of procurement success should always be the outcome that brings the most value to the organization, but this can be hard to define when there are a number of competing viewpoints on what value is.

However, we can define Value as the outcome that balances the tradeoff between the goals of the respective stakeholders for maximum return against an agreed upon value scale that normalizes a dollar of savings (for the CFO) against a reliability metric (for the Chief Engineer) against an expected availability metric (for the Production Chief) against a feature differential against the market average (for the CMO) against a value-add differential (for the VP of Sales) [etc].

Now, you might be wondering how you do that? The answer is simple: define an expected dollar value. It’s not as hard to do as you think (as long as you have the [big] data and the model and the software to calculate it)!

The CFO metric is easy, a dollar of savings is a dollar of savings.

The reliability metric is not that much harder. A failure rate of 90% vs 93% during the warranty period has an incremental cost equal to 3% of the units times replacement cost (which is base product cost + processing cost if outside of supplier warranty or processing cost + return cost if inside supplier warranty) and this cost can be amortized per unit.

The supply availability metric is involved, but still easy to define. First you have to calculate an expected chance of disruption based on it. Once you do, the cost can be approximated as follows: (% chance of disruption * % length of disruption x cost per day of disruption) amortized by units. If there is 10% chance of disruption, then you expect one every 10 years, for the estimated length of time, at the estimated cost per day, and amortize that cost over each unit purchased each year. Not perfect, but a good approximation. To find the conversion from expected availability percentage to chance of disruption, you mine your data and extrapolate the multiplier. Easy peasy (with a modern cognitive or deep analytics platform).

The CMO metric is tricky. Just how much better is that gee-whiz feature? Probably not nearly as important as the CMO claims. To figure out an approximate dollar value per unit here, you will have to mine historical data to see the incremental marketing value from the company’s “most differentiated” or “feature rich” products compared to its “least differentiated” or “feature poor” products as compared to the estimated market share each product obtained. If “feature rich” products typically command an extra 10% of market share, each unit is valued at a premium of 10%.

The value-add is easy — mine the historical data to extract the dollar value of each “value-add” available to the company.

Then, to find the optimal trade-off during a sourcing event, build a multi-objective optimization model that maximizes the overall value generated from these goals.

In other words, what used to be downright impossible is now pretty straight forward with strategic sourcing decision optimization and cognitive sourcing.

What’s the right level of safety stock?

Severe weather events and transportation disrupting natural disasters are on the rise, and the only thing that we can be sure of is they are going to keep coming fast and furious in the near future. We don’t know when, where, or what extent the impact will have, but we know it’s coming.

The resulting disruptions to your supply chain will last days, weeks, or months. And if the part of your supply chain that is disrupted is one supplying a critical component that is sole-sourced or in a supply shortage, any and all products it is used in will be in jeopardy once the inventory runs out. As a result, JiT inventory is becoming a thing of the past. However, too much inventory on hand is NOT a good thing. You want a balance between JiT and everything you need for the planned production run. And that balance could be anywhere from a few extra days (for inventory that can be obtained from another source on short notice) to a a few months (for something otherwise hard to get).

But how do you figure out the right stock levels? It’s not just rarity. After all, stock costs money and ties up working capital … capital that likely has better uses. After all, early supplier payments can bring cost reductions. Investments can bring recurring cast. R&D can develop new, more profitable, products for sale. And so on.

So how do you determine the right level of safety stock? Expand the working capital optimization model to allow for a variable disruption cost based upon variable stock levels, each of which has an associated investment cost (in the form of tied up working capital), and determine the stock levels from the investment that optimizes working capital.

Again, the right level of safety stock falls out of working capital optimization.

The Snares of Sourcing

Sourcing is the key to supply management success, but only if it is executed in an effective manner. Otherwise, there is a risk that the sourceror will make a decision that makes the situation worse, not better.

For sourcing to be effective, it has to add value. Otherwise, there is no benefit to sourcing compared to a procurement spot buy. Value can come in many forms, including, but not limited to, better quality, lower cost, more value-added, services, and guaranteed availability. However, especially from the CFO’s view, lower cost and supply availability are generally the priorities as bottom line improvements depend on cost reductions and sales for profit.

But for sourcing to be effective, the sourceror has to avoid the traps, traps which come from their lack of market knowledge, supply market knowledge, and e-Sourcing expertise. Specifically, if a sourceror has:

  • lack of market knowledge

    and does not understand whether supply exceeds demand or demand exceeds supply, the sourceror can choose the wrong event type — an auction when supply is scarce, a strategic negotiation with the incumbent when supply is plentiful, and so on

  • lack of supply market knowledge

    and does not seek out more knowledge, she could pass over inviting the best suppliers to the event or eliminate supplier with seemingly high or low price points without understanding the additional value they can bring with commitment and buyer expertise

  • lack of e-Sourcing expertise

    and does not know the ins and outs of refined sourcing process and the best way to engage suppliers, extract detailed cost models, or determine the right supply base split, inferior decisions will be made

So how can the sorceror avoid the traps? Especially if she does not have the knowledge? Cognitive sourcing platforms that can fill in the gaps.

A good cognitive sourcing platform will:

  • provide the buyer with up-to-date market knowledge that allows a user to always understand the supply/demand balance or imbalance in the market
  • provide the buyer with a good overview of the current and potential supply base
  • provide the buyer with the typical sourcing strategy for the category and (supply) market dynamics to help the buyer make a decision

Will the cognitive platform always be right? No. But it will be most of the time, and that will help the buyer make better decisions more often. And avoid most of the sourcing snares.

What Should Drive M&A?

Last year was obviously the beginnings of a new M&A frenzy cycle in the Procurement Vendor space. Big names were scooped up by bigger names in an effort to expand their reach and/or capability in an effort to become the biggest name of them all. But is this good for Procurement departments? It depends on the synergy inherent in the acquisition. As summarized in the doctor‘s guest post over on the Synertrade blog on Surviving a M&A: The Customer Perspective, M&A synergies come from operational synergies, customer synergies, or solution synergies.

And these synergies will either come from complementarity or redundancy. Both can, theoretically, have a big impact on the bottom line, but one impact will likely be viewed much more positively than another from the eyes of customers. While bankers and financiers might be satiated with redundancy synergies when overhead prices get slashed and immediate profits rise (thanks to SaaS deals that insure license revenue keeps coming in month after month in the near term), customers are not always happy when their support teams, with whom they have built a relationship with over months or years, are eliminated overnight in one fell swoop.

That’s why the doctor believes that complementarity should drive synergies. For the big wanting to get bigger, they should seek to acquire a smaller provider that provides them with the synergy of complementarity across the customer, solution and operations dimensions. Specifically:

  • Customer

    the provider of interest should have a largely non-overlapping customer base that could make use of the company’s solution in unison with the smaller provider’s solution — for e.g., if a S2P company without in-house analytics is trying to acquire a BoB analytics firm, that firm could likely use part or all of the acquirer’s platform

  • Operations

    the unison of the providers should allow both parties to do more with the same back-office staff; i.e. the combined company should be able to grow without adding staff (and, moreover, the current staff should, more or less, be the best staff to grow the combined company)

  • Solution

    the solutions should complement nicely without too much work and should not overlap too much

Vendors should not pursue mergers that get synergy from redundancy. Having to scrap platforms, cut people, or, even worse, having to make decisions that negatively impact the current customer base (that talks to their peers).

It might be the case that the best provider is not as big as desired, or that the best provider doesn’t have all the desired solutions, but, as the tortoise taught us, slow and steady wins the race. And even if the new combined company has to build a bit more than they would like to, a combined, synergistic, team always has an edge.

Good Working Capital Management is More than Just Timing Payables and Receivables

A few years ago we ran a post on the essence of good working capital management. We noted that, at least from a basics point of view, all one really has to do is:

  • Get a grip on receivables.

    When are the customer payments for sales due? The reimbursements from suppliers for reaching volume tiers due? The tax rebates?

  • Get a clear picture on fixed payables.

    What is the average monthly payroll? Overhead? And projected supplier invoices?

  • Get a good estimate of average disruption costs.

    If a receivable isn’t received on time, what’s the impact? Especially if it could impact a supplier payment schedule which needs to be maintained to insure timely supply.

This is the foundation, but in today’s unstable and unpredictable business environment, that’s not enough to maximize working capital management. To maximize working capital management, one has to maximize the value of the capital. In order to maximize working capital, you need to know when to use capital for internal costs, for supplier payments, and for investments. This means one also has to:

  • Understand the value of early supplier payments.

    Not just the value of the early payment discount, but the overall value to the supplier. If they don’t have to borrow at a cost of capital two or three times the buying organization, and then pass that cost on to the buyer in their overhead, that’s a big potential savings to the organization — even if they have to borrow.

  • Understand the organization’s cost of borrowing.

    If the organization can borrow at a low interest rate of 3% or 4% a year in their home market, whereas a supplier can only borrow at a high interest rate of 12% to 20% in their market, the organization can save by borrowing. But you don’t borrow just to save on costs, you borrow to profit. If you can accelerate production and accelerate profitable sales, borrowing is sometimes a pittance. And if you have good investment opportunities, that could also be a good reason to borrow.

  • Understand the organization’s investment opportunities.

    How much from accelerating production? Improving the process? Investing in R&D? Investing in subsidiaries.

Then, when you have all of this information, you do one more step:

  • Build a Working Capital Optimization Model

    and run it. Input all the receivables, payables, disruption costs, early payment opportunities, borrowing opportunities, and investment opportunities and let an optimization-backed cognitive system help you put a plan in place to not only manage working capital, but profit from it.