Category Archives: Best Practices

Enhancing MRO Supplier Value through Contract Service Levels

Today’s guest post is from Jennifer Engel, a Senior Supply Chain Project Analyst at Source One Management Services, responsible for executing strategic sourcing and process improvement initiatives.

Despite the convenience of boilerplate language and pre-approved templates to expedite execution, contracting is never a one-size-fits-all process within any silo of a business. Contracts for professional services tend to require a focus on performance expectations, and rarely have a need for protection against pricing volatility, lead time requirements, and fuel costs. Diametrically, contracts for the tactical purchase of goods focus not on service levels, but on maintaining pricing, ensuring product availability, and outlining delivery terms.

A trait often unique to the Maintenance, Repair, and Operation (MRO) space within a business is that many suppliers are providing a combination of both goods and services that support overall operations. As a result, contracts within this space are difficult to mold to a single template, and constructing agreements without taking into account the business needs to cover each area can be detrimental to the overall relationship goals. When undergoing contracting with a new or existing supplier, there are a few key principals to keep in mind that will benefit both parties as well as drive best value in pricing and service levels.

#1) Fully assess the risks associated with the goods and services separately

When negotiating terms, it is important to prioritize the areas that could most drastically impact the business should a change occur. If the pricing of a good is tied to a volatile commodity index or may be subject to interruptions due to raw material availability, protecting exposure to these factors should be at the forefront of the agreement. If the service associated is more critical than the actual good, for example a specific sanitation chemical being less critical than the completion of the actual sanitization process, then the level of service needed to ensure the business can continue to operate at or above standards should take priority. This primarily holds true to categories for which product substitutes are widely available, however the end result of the service is critical to business continuity.

#2) Adjust the terms of the agreement to form a mutually beneficial relationship that does not expose either party to significant risk.

Explicit service levels and pricing escalators and de-escalators inherently protect the business from any supplier shortcomings or market changes. As long as commodity increases are tied to a verifiable index, are accommodated by a manufacturer’s letter and advanced notice, and de-escalate at an equal rate should pricing decrease, the supplier is protected from becoming insolvent and the customer is protected from realizing an increase not driven by market conditions. For goods not driven by an identifiable index, pricing increases should be capped at a reasonable rate and subject to review and mutual agreement of the involved parties.

#3) Leverage rigorous service levels as another tool to drive negotiations and ultimately satisfy both parties.

As long as supplier expectations are detailed, measurable, and tied to a condition of termination with cause, there is less business risk to include contract language that may be viewed as more favorable to a supplier than the customer. A common point of disagreement in most MRO contracts is term length. Businesses are hesitant to engage in two or more year agreements with fear of dissatisfaction in a supplier’s performance. From a supplier standpoint, these lengthier terms allow them to invest more heavily in a specific customer without risk of being replaced in the near term. As a result, suppliers are often more likely to give more favorable pricing and terms under these extended agreements. Another point of leverage that incentivizes suppliers to offer more competitive terms is exclusivity clauses or volume commitments. Both can be high risk for a business to include, however are easily protected under strict service levels and quality expectations outlined in the agreement.

When putting together such agreements, stakeholder involvement should go beyond the legal department and relationship owner (department manager and/or procurement). End users, and those more closely aligned with the day to day operations should be consulted to outline critical functions of the supplier and bring to light any historical or future potential issues that will impact the integrity of the relationship or daily operations. Contracting should be viewed as opportunity to maintain and strengthen the relationship from both parties, and not seen as a necessary evil of back and forth on general language until legal departments reach consensus. Dedicating the extra resources necessary to construct a detailed and forward thinking agreement will prove beneficial in the long term, as company standards will be maintained without sacrificing cost competitiveness.

Thanks, Jennifer.

Anchoring Doesn’t Have to be a Problem …

… or even a concern, if you approach negotiations in a fact-based manner, instead of a seat-of-your-pants manner, like most negotiations are approached.

What are we talking about? We’re talking about the tendency for us to fix our thoughts around a particular number, point, or fact rather than thinking logically and independently about a decision. In particular, the fixation that occurs when people consider a particular value for an unknown quantity before estimating the quantity. From that point on, the estimates then stay close to the number considered, even if the estimate is way, way off. The absolutely proven phenomenon discussed in detail in the public defender‘s recent pro piece over on Spend Matters + on how to hone your procurement negotiation skills by learning the right way to think (fist part free, full article requires membership).

Anchoring happens if you begin your negotiation or event with a price that is based on current price, a recent supplier quote, a market index, or some other number that may or may not have any basis in reality. Anchoring is avoided if you start with a price that is based on a should cost model, for a product, or an amalgamated index by a large analyst firm or statistics bureau for services category.

The should cost model should be based on a detailed cost breakdown that takes into account raw material costs (at market indexed rates), average labour costs for a region, average overhead costs, and any advances in production technology. A current cost, a current market cost, or even a project cost from a trusted supplier is not a should cost – and negotiations should ALWAYS be based on should cost. It might seem a waste of time for a product you’ve sourced ten times over the past ten years, or a service that you’ve paid the same rate for from three different manpower suppliers over the past three years, but that’s a very small sample of the market price at large, or the should cost price.

So do a detailed should cost model (or, for a service, detailed market research and break it down against average salaries available through a number of portals, augmented with standard contractor / manpower / outsourcer mark-up) and start your negotiations around that reasonable, logical, point — even if it’s half of what the supplier is quoting. Remember, you can scream that they take their unreasonable cost off the table or you walk because you can say “look, I have a should cost model right here that backs up the reasonableness of my number — so we’re starting within 20% of this and adjusting as necessary, or we’re not starting at all”.

Is Category Management a Prism? Or a Telescope?

Over on Procurement.World, the procurement dynamo tells us that category management is a prism. More specifically, the procurement dynamo tells us category management is about looking at spend through the prism of

  • company strategy
  • internal customers’ needs
  • supplier/supply market

Through these lenses, procurement will determine if it should be focussing on categories, value drivers, required supplier capabilities, and supply assurance. How?

According to the procurement dynamo, by going through the key components of the category management checklist and seeing where they lead.

So what are the components? You can download the checklist [registration required] and review them yourself, but, needless to say, they revolve around:

  • taxonification
  • supplier classification
  • category strategy from an organizational, stakeholder, and procurement perspective
  • sourcing strategy
  • ROI calculations
  • action plans
  • governance
  • measurement

But is it a prism, or a telescope — a linear sequence of lenses that serves to sequentially focus in on a particular category definition, strategy, execution plan, and return. By the time you go through the incremental category evaluation and strategy and execution, you typically have one view, one color on the problem — not a rainbow. Traditional category management typically ends up with one way to look at the category, not multiple.

It probably should be a prism — as the strategy should change with the market conditions, the customer needs, innovation capability, and so on — all features not considered in a fixed plan and linear workflow. But will it be? And how do we make it one? Thoughts?

eBid Systems – An Old Procurement Provider with a New SaaS Sourcing Solution

eBid Systems started out as an ASP of (custom) procurement solutions for the public sector back in 1999. While relatively unknown in the private sector, this vendor is well known in the public sector, having grown over the last 17 years to a large provider of ASP and (multi-tenant) SaaS solutions to over 200 public sector organizations of all shapes and sizes and about 100 private sector organizations (that primarily serve the public sector).

Even though the e-Sourcing market is well established, and, despite the recent M&A frenzy, there are still a handful of mature mid-market e-Sourcing offerings for a mid-market company to choose from, eBid Systems decided to re-enter the market with a new SaaS e-Sourcing solution called, ironically, ProcureWare, which has been in re-development for the last three years.

A few years ago eBid Systems realized that if they were going to accelerate their growth, and increase penetration in the private sector, they needed to get out of the custom software and ASP business and into the multi-tenant cloud-based SaaS business and rework their platforms into a nimble, quick to setup, easy to use, competitive turnkey e-Sourcing solution. And for the last three years they have been developing that suite. The result is a solid mid-market entry with solid RFX, e-Auction, Reporting, basic SIM and basic CLM and, just like ScoutRFP, enough to get the attention of new converts to e-Sourcing, especially in the mid-market. Plus, their experience in the public sector is very attractive to those companies looking to get, or increase, public sector customers.

The RFX solution allows for detailed creation of information request forms, pricing request forms, and scoring schemes — which can be split among multiple reviewers. The RFX can be sent to selected suppliers, or opened up to any supplier on the eBid network for bidding.

Bids consist of all responses to the RFX, any associated documents the supplier wants to upload, questions (or clarifications) that are asked, and responses that are provided. Suppliers and Buyers can drag and drop documents into the platform and a complete audit trail of all bids, changes, clarifications, and responses are maintained in the audit log.

The (reverse) auction works like a standard low-bid auction, but the interface is RFX line-based. There is no graphical interface at this time. However, the platform also supports forward auctions for the disposal of excess inventory, which some public sector organizations find useful.

The supplier information management (SIM) is quite extensive and extremely customizeable by eBid Systems and can track not only all basic company information, financial information, and even compliance information, but can be customized to track appropriate diversity, public sector classifications, and insurance certifications. A supplier record can also be associated with all contracts and associated bids.

Contract management is all about managing and tracking awards, vendor obligations, and associated data — it is not about contract document creation or tracking of contract documents and deliverables. It’s primitive at the moment but could prove more valuable as time goes on. Contract data is primarily used for alerts, as the system can alert to expiring contracts, expiring insurance, diversity review dates, and so on.

eBid Systems market entry is solid and shows promise. SI expects that we could see a strong uptake in mid-market organizations in the private sector that primarily serve public sector organizations and continued, steady, growth in the public sector. Time will tell. Regardless, for those interested in a deeper dive, check out the recent deep dive by the doctor and the prophet over on Spend Matters Pro [membership required]. (Part I).

Why Isn’t Procurement Changing?

It’s a good question, and one the procurement dynamo recently tackled over on procurement.world. According to the dynamo, multiple factors are at play, including, but not limited to:

Big Jelly Theory

Attributed to Paul Finnerty, the ‘theory’ is that if you throw yourself and your team members, 100% mentally and physically, at the organization, in an attempt to change it, at best the organization will give a little shiver, momentarily, like a giant jelly, and then immediately return to its pre-existing shape and carry on, with business as usual, as though nothing has happened.

Irrational Actors

Attributed to Charles Jacobs, brain cience has found that human beings are anything but reasonable… When it comes to motivation, our approach is based on the view of classical economic theory that people are rational beings trying to maximize their economic return. This leads us to use the promise of rewards to motivate the behavior we need. But in direct defiance of the theory, people don’t respond reasonably or objectively to the rewards.

But are these the only reasons? There are two reasons that modern Procurement solutions aren’t adopted. The first is the people. They can resist, resist, and resist. The second is the management.

Management with Revolving Door Priorities

When Management falls for every fad of the day and changes priorities, processes, and even technologies every couple of years, employees get jaded and even more resistant to change then they’d naturally be. The Big Jelly gets bigger.

Maury the Management Moron

Sometimes the team, who want to do well and get their bonuses, will come to the conclusion they need a new solution, go through a detailed evaluation and select one they are willing to give an honest go. But, Maury the Management Moron, who will just see the price tag (and not the ROI) and correlate it with a potential negative impact on his bonus will say no. And that’s the end of the Procurement progression.

So, when trying to figure out a way around the conundrum, you have to go beyond just people and look at roles and how the values change as the role changes. And take that into consideration when applying your economic theory. (And, sometimes, wait for Maury to be shown the door.)