The Business Continuity Institute (BCI) recently released the main results of its study across 35 countries that found that 70% of organizations recorded at least one supply chain disruption in 2010. While this is not news, as the statistic has been this high for a few years now, what is news, as highlighted in a Procurement Leaders summary is that where businesses have shifted production to low cost countries they are significantly more likely to experience supply chain disruptions, with 83% experiencing disruption. In other words, your chances of a disruption are greater than 4 in 5 if you use low-cost countries! With an average disruption cost exceeding $700,000 ten percent of the time and an average impact on stock price of 9% (source: PWC), there’s nothing low-cost about low-cost country outsourcing once you factor in the losses from the inevitable disruptions!
Then, when you add the fact that 1 in 5 disruptions result in (serious) damage to your brand, you need to ask yourself why so many of you still believe in this fairy-tale. It’s equivalent to looking for the pot of gold at the end of the rainbow. You’re not going to find it.
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As Bob will tell you again and again one of the keys to a successful career in Procurement (which includes a seat at the C-Suite’s table) is to speak like a CFO. But if you want to keep that seat, at some point you will have to think like a CFO or you will quickly be dismissed if your plans don’t measure up to their high expectations upon careful review.
But how do you think like a CFO when it’s often challenging enough just to speak like one? A recent article in the McKinsey Quarterly had some good advice to get you started.
According to the CEO’s guide to corporate finance, the following four principles will help you choose the alternatives that qualify as great financial decisions and that will win you a lot of attention in the C-suite.
- The Core-of-Value Principle
Value creation is a function of returns on capital and growth. Procurement should pursue projects that will generate returns in terms of productivity or cost reduction and should not ignore potentially high-return projects (such as an investment in a new, but unproven, supplier who uses a new technology) just because there is a moderate downside risk.
- The Conservation-of-Value Principle
Only improving cash flows will create value. Don’t pursue projects on expected ROX (ROI, ROE, etc.) metrics alone. Make sure there will also be an impact on cash-flow in a reasonable time-frame. For example, a piece of shop-floor technology that is expected to improve efficiency by a factor of 30%, reduce production costs by 15%, and generate an ROI of 5X over a 3 year life span is not worth it if it does not free up any cash flows for two years because most of the production costs are labor and labor can’t be reduced or reassigned in the short term.
- The Expectations Treadmill Principle
Movements in a company’s share price reflect changes in the stock market’s expectations about performance. The better the share price does, the better the company is expected to do. When the share price is increasing, the focus needs to be on projects that will support long-term growth (such as advanced data analysis systems that will allow the organization to identify cost reduction opportunities going forward).
- The Best-Owner Principle
No business has an inherent value in and of itself. (It has a different value to different owners or potential owners–a value based on how they manage it and what strategy they pursue.) Procurement should participate in regular cross-organization business-unit reviews and make sure it is still the best owner of each and every function under its control. If it is not the best owner of a function, the function should be reassigned or outsourced, and if it could be the best owner of a function controlled by another business unit, it should be willing to take that function over.
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