One Hundred and Thirty Five Years Ago Today …

The first standardized incandescent electric lighting system employing overhead wires, built by Thomas Edison, begins service in Roselle, New Jersey, just a year after Edison switched on the first steam-generating power station at the Holborn Viaduct in London, England.

In other words, while the vast majority of people alive today who were born in a first world country grew up with electric street lighting, it’s not that new. And when you consider the amount of time we’ve been on this planet from a scientific evidence point of view, it’s amazing how far technology has progressed since the delivery of the first stable feeds a little over 135 years ago …

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.