Category Archives: Best Practices

Hi-ho. Hi-ho. It’s Off PO We Go!

Or do we?

A few years ago Jason the prophet Busch wrote a post over on Spend Matters that asked “can (and should) we eliminate purchase orders (POs) entirely”? In the post he quoted Tom Linton, CPO & Supply Chain Officer at Flextronics, who suggested that we eliminate POs entirely as a result of his mandate to eliminate work before you automate, automate work before you move it and always make sure you improve outcomes in any given scenario.

Mr. Linton is entirely right — there’s no point in automating unnecessary work. And in many circumstances Purchase Orders are entirely unnecessary. If the contract specifies a delivery schedule with approved rates, then there is no need for a Purchase Order since it would just be replicating what’s in the contract. Similarly if it’s for services and approved projects, resources, and rate-tables are defined against a project schedule (unless overtime exceeds the maximum overage allowed).

In this situation, you can just conduct the 3-way match against the goods receipt and the contract when the invoice comes in and you are still certain that you have payed the right price for the right good from the right supplier at the right time.

But what about the situation where there is no (master) contract? What then? You just match the invoice to the goods receipt? I hope not! In this situation you can verify you are paying for the right goods from the right supplier at the right time — but not the right amount. You need to verify that the price is right (because, as the line goes, it can all be yours if the price is right). So in in this case you need something. A requisition? Nope – that’s not sent to the supplier, that’s sent to your supervisor/manager for approval. A one time contract for a single purchase? Isn’t that just a purchase order?

The purchase order can’t be eliminated, because proper purchasing procedure dictates that all purchases should be for approved products from approved suppliers at approved prices and such approvals should be documented in some form — be it a contract schedule or rate card, purchase order, catalog, or approved rate range for a T&E expense — and there are some instances where the only viable option will be a purchase order.

But an effort to eliminate as many purchase orders as possible will be a good and productive one because, like invoices, each and every purchase order comes with a processing overhead cost that adds up and costs the organization significantly over time.

If One Wants to Avoid Cost, Then One Should Avoid Cost At All Costs

One would think this would be obvious by now, but it’s not. Most organizations still talk about savings, savings, savings long after there are no savings left to be had instead of cost avoidance (and the successor topic of value generation). The best way to save money is not to spend any in the first place.

More specifically, it’s great if you negotiate the cost of a case of paper from $50 down to $40 but it’s even better if you don’t buy the case in the first place! That’s a 100% savings instead of a 20%! Now, it’s probably safe to say that paper spend can’t be eliminated, but most printing goes into the recycling at most companies the day it is printed, and that certainly can. How? Look at why people feel the need to print reports, articles, invoices, etc? Is it because they are in AP and they have to manually enter data coming in on a scanned PDF that can’t be properly parsed with OCR into the AP system, and they only have one monitor? Is it because the sales team / executives only have a small laptop screen and can’t see the report details adequately? In the first situation another standard monitor for $150 will eliminate the need for the AP staff to print out paper every day and save you cases on a monthly basis for years to come! In the second, spending $300 to $500 on a large screen will save the executives from having to print.

And SI is really glad to see it’s not the only blog taking up the cost avoidance cause. In a recent post by the maverick on the new CPO site (in which the doctor is currently doing a lot of collaboration to define what a CPO is, what she needs to know, what she needs to do, and what no other site will tell you) in which he addresses how “Most Firms Ignore Cost Avoidance [And] Destroy Economic Value”, we find out that it is just important, if not more so, because, to be blunt, cost savings is just a special cast of cost avoidance where you avoid paying the supplier more than you need to in order to acquire the product (while insuring the supplier is still sustainable).

At the end of the day, it’s all about spending as little as possible to get what you need in a sustainable manner. This essentially says it’s all about avoiding as much spend as possible while still getting what you need in a sustainable manner. Cost Avoidance is key, regardless of what your definition is.

Just What is “Best Value”, Part Deux!

In yesterday’s post, we discussed an article in a recent edition of Purchasing Tips (by Charles Dominick of Next Level Purchasing) that asked What is Best Value Procurement where he stated that “best value” should be a hard metric measurable in financial terms and expressed in units of currency and not a soft metric where factors other than price are used in determining a supplier and/or product to select for purchase (as that is weighted average supplier/product scoring).

We noted that SI tends to agree, but that there are often issues with trying to assign a(n exact) hard dollar revenue increase or cost decrease to an event that has not yet happened. Even the illustrative example used by Mr. Dominick in trying to choose between machine A and machine B to automate a production line is not cut and dry. For example, if the organization stops manufacturing a product before production line end of life or has the option to lease vs. buy the machine, the calculations get complex. But this is just the beginning.

When it comes to making an IT purchase, the “best value” calculations become a bit of a nightmare. First of all, there is system cost. Depending on whether you want to go with a true SaaS, hosted ASP (which might be wearing a cloud disguise), or on-site hosted solution, as discussed in our classic series on the Enterprise Software Buying Guide (Part V: Cost Model), there are anywhere from four to eleven core up-front and on-going costs that need to be considered (plus ancillary costs for complex or special systems). (And even with the free calculation template provided in the classic SI post on uncovering the true cost of an on-premise sourcing/procurement software solution, the calculation is still a nightmare. How confident are you in the integrator’s estimate? How secure do you feel about the amount of training time (and budget) that will be required? How reliable are the ongoing support level and associated cost calculations.)

Assuming you can work through the system cost equation, which can be quite a doozy (doozy, not doozer, although you will likely need doozer cooperation levels to make any new IT system work these days), you then need to work through the value equation. Just how much value can be expected from the system over the timeframe, and how accurate is that prediction. There are multiple components to this calculation.

  • Throughput Increase
    if the system increases the number of invoices that can be m-way matched, increases the number of sourcing events that can be run, or automates the production of trade documents, this needs to be calculated first as these numbers are need to compute the savings
  • Efficiency Savings
    how much manpower is saved (and how much can therefore be reassigned or eliminated) and how much is the HR expenditure accordingly reduced
  • Cost Savings
    how much cost is expected to be avoided either by increased throughput or the increased performance offered by the system (such as defect reduction, which reduces repair costs)

Obviously, these calculations are not straightforward. In the case of efficiency savings, since every resource (and type) has a different cost (based on salary and associated benefits), the best you will be able to do is estimate an average cost for the manpower by hour (or day). In the cast of cost savings, it’s more than just an industry average, it’s an industry average for a company at a similar stage of competency, with a similar sized workforce, and a similar production or spend pattern. Let’s take spend analysis. If the company is a leader with close to 80% of spend under management, has been sourcing against industry benchmarks, and has used advanced negotiation (and optimization) techniques on high value or key categories (with the help of a third party, if necessary), the company is likely not only aware of its top n categories, but has likely strategically sourced the majority of next n categories as well and the untapped opportunities would represent less than 20% of its spend. This company would only expect to see the industry average 11% savings on roughly 10% of its spend and would likely only see a few percentage points on the spend under management in the current economy. In comparison, if it is an average company only had 45% of its spend under management, had not used advanced sourcing techniques in the past, and only sourced a few categories against benchmarks, it might expect to see the industry average savings of 12% on 40% of its spend and 5% to 6% on the rest. The up-front savings potential (over 1 to 3 years) for this average company on a new spend analysis system would be four times that of the industry leader! It might be the case that the industry leader might need the new system to properly monitor and analyze its spend going forward more efficiently to help it avoid bad decisions in the future, but now we are in cost avoidance territory, and fuzzy territory at that. In hard dollar costs, all one can argue is additional manpower reduction.

And we still haven’t dived to the bottom of the iceberg. In other words, the best definition of best value is a hard dollar metric, but it might be the hardest metric of all to calculate.

Just what is “Best Value”?

In a recent edition of Purchasing Tips over on Next Level Purchasing, Charles Dominick asked What is Best Value Procurement? In the article, he notes that many people use the term “best value procurement” to describe purchasing decisions where factors other than price are used in determining the supplier and/or product to select for purchase and states that he believes that this is “weighted average supplier/product scarring”, which it is.

In his view, value should be measurable in financial terms and expressed in units of currency. I tend to agree, but there are issues with trying to assign a(n exact) hard dollar revenue increase or cost decrease to an event that has not yet happened.

In his illustrative example of choosing between machine A and machine B to automate a production line and reduce the labour needed to keep it running (in an effort to, hopefully, allow the organization to either redeploy the personnel on higher-value tasks or, if not possible, replace those jobs with jobs that could generate more value for the organization down the road), it seems cut-and-dry. Just compute the value-to-cost ratio (where the value, as defined by the estimated labour savings, is divided by the cost of the new machine, which should include purchase, installation, and additional maintenance costs over the expected lifetime). In this case, one machine will generate a higher value-to-cost ratio and that is the machine you should purchase for the organization.

Assuming, of course, that you are sure the machine will have the indicated lifespan and will be useful to you for that lifespan. For example, what happens if you stop making the product in three years but your value calculations are for five years, the expected lifetime of the machine. The value-to-cost calculations will still rank the machines in relative order (as only the value changes), but the return might not look so enticing. And what about the situation where you can instead lease one of the machines from a third party (instead of buying it) and, because that machine in particular is made to a higher quality standard, get an annual lease that is only 1/10th, and not 1/5th, of the purchase cost? In this situation, a machine that cost twice as much would not only have the same value-to-cost ratio but, if you had to sell the machine you bought after three years, the leased machine would have a higher value-to-cost ratio since you’d likely not get the full undepreciated book value for the machine you bought.

And this is just a “best value” calculation on a simple piece of machinery. Consider the difficulty when trying to compute a “best value” on a technology platform purchase, where such platform is intended to improve your sourcing, procurement, supplier relationship management, or similar supply management process. It’s not just up-front cost. It’s implementation. It’s maintenance. It’s operational manpower savings on tactical tasks. It’s efficiency improvements (which have a value in terms of more events or throughput, which translates into generated value) and it’s additional cost reductions identified through the platform (which can be estimated based on benchmarks, but not predicted). How do you do that “best value” calculation? What number do you use? Do you compute a range and use the middle? Do you identify all platforms with a minimum acceptable value-to-cost ratio in terms of guaranteed hard-dollar savings and then select the best-value using the platform with the maximum value-to-cost potential?

There are no easy answers and costs alone don’t always tell the whole story.

Simply Your Procurement Life and Eliminate the 5 E-procurement Mistakes You Don’t Realize You’re Making

Today’s guest post is from Iyana Lester, a Project Analyst at Source One Management Services who specializes in contract management and negotiation, project evaluation and monitoring, and market assessments.

Along with the boom of internet-based business came the challenges of maintaining an effective supply chain in the digital space. E-procurement offers a seamless solution to streamline processes and improve compliance all while reducing cost. While e-procurement has been around for several years, there still remains several factors that impede businesses from utilizing it fully and attaining maximum savings largely based on their expectations.

A recent Procurement Insights article points out that merely assuring yourself you’re doing everything in your power to maintain supplier relationships isn’t enough. “Even if you are well-versed in procurement and can speak every language in existence, nurturing complex supplier relationships in a global spectrum requires frequent communication that often slips without a system to manage the contact.” So what does this mean for organizations considering the shift?

Inform yourself of what’s out there before committing to one e-Procurement solution. More importantly, become educated on the user short-fallings that lead people to assume that their solutions aren’t optimal. This will allow the largest-scale view of your options without any user-impairment bias. By ensuring your expectations are reasonable, you’re conveniently building yourself a ladder out of a situation coined by Sourcing Innovation as Procurement Damnation. Whether you prefer it as a remix to AC/DC’s Rock ‘n’ Roll Damnation or a procurement state of agitation, you can’t anticipate unrealistic savings and results from an e-Sourcing platform. These solutions are helpful in approaching the challenges of global sourcing, but they are only 100% effective with a strategy that supports them.

Below is a list of several of the most common shortcomings faced in e-procurement. As you develop your e-Sourcing options, keep these organizational glitches in mind:

1. Poorly Implemented Systems

This issue stems from a lack of initial planning. The systems must be integrated with existing corporate systems so that they will be interacting all the way to the end user’s interface experience. They should also be implemented quickly to accomadate any rapidly-developed new technological advancement. Failure to consider any of these focuses can result in systems that aid in one area of the procurement process but cause harmful disruption in others.

2. Partial Implementation

When implementing any large scale change, the change must be adopted and interconnected organization-wide to achieve optimal outcomes. To successfully implement e-procurement, your organization needs to carry out a detailed evaluation of its procurement processes and consider the needs for each division. Roles will continue to depend on effective collaboration between many different organizational players. This will assist in preparing proper agendas and budgets.

3. Uninformed to the Latest Technological Advancements

Monitoring advancements in e-procurement technology will serve as a guide for key risk concerns that should be in your organization’s radar. Observing technological advancements will lessen the chance of your systems becoming outdated.

4. Failure to Develop Performance Metrics

Many organizations have the mentality that once a system is in place, all advantages and will be manually achieved. Considering a comprehensive set of metrics provides a better framework for benchmarking and allows for the procurement process to be more effectively managed. Some metrics areas to consider may include effectiveness, efficiency, quality, and cycle time.

5. Unsuccessfully Identifying the Issues at Hand

A system cannot effectively solve a problem unless the true problem is identified. Organizations often identify sources and causes of the problem and look for fixes that will only temporarily improve the issue. To capture the full potential of your e-Sourcing, never close your eyes to developments and minimize your exposure to Procurement Damnation by following the above steps. The most effective procurement management systems are constantly adapting their capabilities while remaining user-friendly and consistent. Procurement departments should be mindful and eager to pursue new functionalities wherever possible without compromising supplier data quality.

Thanks, Iyana.