Daily Archives: July 5, 2017

Once Upon a Time, Not So Long Ago …

Investors used to look for the long term. Even Wall Street promoted companies that looked to the long term. Companies would form, and invest in, R&D labs that wouldn’t realize products for five years and returns for ten. Because they knew that, with the right investment, over the right amount of time, the payoff would be enormous. Maybe even gigantic. 10X would happen, and more. Maybe 20X or even 30X. Not over night, but over time. They didn’t expect 10X returns in 3 years. They were willing to wait a decade or more.

Who wouldn’t be willing to wait a decade for a 10X return. Especially when 10X your money every ten years means that in 30 years you’ve increased your money by 1,000. That means that 1,000 today nets you 1,000,000 in 30 years. Given an average rate of inflation of 1.35% per year, in 30 years, you’re 1,000, uninvested, would have depreciated by a third. And the thing is, if you invest in a relatively safe bet, your odds of getting that 10X return in ten years are quite high. Considerably more than the odds of investing in a random startup. Whereas the odds of investing in a new startup with barely an MVP, no track records, and essentially no real, paying customers might be 1 in 10, the odds of a company or product that is solid, growing organically, and currently experiencing year over year growth at a rate of 30% to 50% continuing to grow at that rate is likely at least 50% with the right investment. A growth rate of 30% over ten years increases your money by a factor of 13.79 and a growth rate of 50% over ten years increases your money by a factor of 57.67. If you started with 3,000 and only every third bet paid off, you’re still getting that 1,000,000. In fact, you’re probably getting 2,000,000 to 3,000,000. So why wouldn’t you play it safe and wait?

If you’re not a total idiot, you would. So, taking the same logic, in Procurement, why do you push for savings today over value tomorrow? Even though real savings go straight to the bottom line, fake savings don’t. And when you get taken in by a large near-term potential savings opportunity, chances are it won’t materialize whereas a long-term value-generation plan, that comes by way of supplier development that will lead to guaranteed savings through lean process improvement, elimination of a dependency on a rare earth metal or other raw material in limited supply, reduction in energy usage requirements, and so on.

So what do we mean by fake savings? Fake savings is the projected savings opportunity that comes from an award allocation that requires shifting a large part of supply to an unproven supplier, or an untested product, typically in a low cost country, that looks great during an auction, but will never materialize because the buying organization didn’t do a detailed cost analysis and doesn’t realize the extra costs with offshoring or switching.

For example, maybe the supplier doesn’t speak, or read, English as well as they claim and stated they could fulfill a requirement with their current manufacturing line, but couldn’t, and needs to make additional investment and production line upgrades, which will take the plant offline for a few weeks. This could result in a significant delay which would, in return, result in lost sales and possibly even lost customers. This is costly. Or maybe the supplier can’t produce products of the same quality, and the defect rate is not 1%, but 5%. Not only will this increase costs by almost 6% off the top as you will have to order 6% more product, but then there is the return processing and warranty costs and costs associated with dissatisfied, or defecting customers. Or maybe the supplier hid the true costs associated with the product by claiming their product fell under one H(T)S category, but actually falls under another, at double the tariff rate. Or maybe they gave you their office address and you modelled logistics costs based on that, but their factory is 200 miles away in the middle of freakin’ nowhere and your logistics costs are 30% higher. And so on.

The reality is that mega-savings don’t exist in big, strategic, established categories where experts have been digging for savings year over year. Generally speaking, you’re not going to find more than 10% to 12% in an established category, and you’re only going to find that level of savings once every five years on average, and only using strategic sourcing decision optimization which looks at the global category and all the viable options that go beyond what a buyer can consider or an auction can capture.

And once those big savings are found in the category, the next round of savings will only come from supplier development (and that’s why you have to cycle through all your categories over a three to five year period with optimization as the next round of deep 10%+ savings won’t come until new innovations materialize that more progressive suppliers adopt that can allow for the next level of savings in the category). And that’s why it’s often better to invest in long term value generation than short term savings. Big savings rarely materialize in the short term but investments in long term value, like investments in solid companies and products, almost always pay dividends year over year over year.

So, with the greedy Wall Street mindset running corporate America these days, will we ever return to “Once Upon a Time …”?