Category Archives: Best Practices

The CPO Agenda’s Procurement Checklist for Staying Center Stage

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Now that Procurement has received board attention as the greatest potential for cost savings in the organization, CPOs need to start planning on how they are going to keep that attention once the recession ends and the spending monkeys try to steal the spotlight again. Thinking (way, way) ahead, the CPO Agenda recently put together a good checklist for “staying center stage” that summarizes some of the key strategies that CPOs will need to pursue to help the board see Procurement as a driver of growth, innovation, and long-term cost reduction and not just a one-trick cost-saving pony.

  1. A Vision for Growth
    • Value Chain
      As the central point of the organization, Procurement is in a prime position to define organizational needs, asses the capabilities of internal resources, and define organizational core competencies. What other business unit touches not only every other business unit, but all of your partners as well?
    • Solution Procurement
      Procurement can source solutions that leapfrog current best-in-class and create a paradigm shift in customer value.
    • Innovation
      As the glue that binds modern organizations together, Procurement can play a critical role in the innovation process by bringing partners and ideas together.
  2. Customer Relationship Management
    As the one business unit that has every other business unit as a customer, Procurement is in a prime position to help the company better meet its customer expectations.
  3. Supplier Relationship Management
    Procurement is already managing supplier relationships on a daily basis … it just has to help the organization understand that it needs to be the central point and the channel by which supplier capabilities are secured to support the company’s growth agenda.
  4. Supply Chain Optimization
    Without an efficient supply chain, companies cannot support the chosen customer needs. In order to achieve its plans, all aspects of a company’s supply chain MUST be optimized. Procurement is in the best position to do that.
  5. M&A Due Diligence
    The ultimate success of a merger or acquisition depends on whether or not the combined organization will be able to deliver more savings and more value … Procurement is in the best position to help make that call.

Overhead Cost Cuts Don’t Provide Long Term Savings

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I was very pleased to see this recent article in Purchasing that noted that “cost reduction efforts require more focus than sacrifice” because all too often I see companies blindly focussing on fixed cost reduction, which, in fact, just costs them more in the long run.

You see, when you cut travel, you cut the ability for your people to make, and maintain, relationships. When you cut entertainment, which is typically a very small budget to begin with, you increase stress, which decreases productivity. When you streamline operations, things start to slip through the cracks. Then when you cut workforce, you cut capability, key processes get skipped entirely, critical sourcing events just don’t happen, and you keep sourcing off of expensive ever-green contracts and spot-buying at high prices. When you cut training, your staff’s skills get even more outdated and your cost reduction efforts miss the mark. And when you cut compensation, your best employees feel unappreciated and trampled on, stop giving 100%, and start looking for their next job.

As the article says, you have much better opportunities, including:

  • transaction processing
  • supplier management
  • health care benefits
  • IT assets (hardware and software)
  • logistics

A Brief Review of Supplier Relationship Management Basics

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A recent article over on SupplyManagement.com on “6 steps to better SRM” provides a good review of the basics. Even though times are tough, chances are, they are tougher for your supplier which makes good relationships even more important. First of all, you want to be the customer of choice because your supplier likely has less staff to service their customers. Secondly, you want to be the first to know if any of your strategic suppliers are in danger of going under, so you have a chance to either bail them out or find other suppliers before you run into inventory problems. Finally, like all recessions that have come before, this recession will end, demands will rise, raw material shortages will occur, production capacities will be hit, and you definitely want to be the customer of choice next time this happens.

So, how do you start? The SupplyManagement.com article recommends these basic steps:

  • Segment the Supply Base
    You need to know which suppliers are tactical and which are strategic because you focus your efforts on your strategic suppliers.
  • Secure Executive Sponsorship
    C-level executives must be engaged in the management of the most critical strategic suppliers and be behind your SRM initiatives 100%.
  • Embed Processes and Governance
    Processes, roles, and responsibilities need to be documented, readily accessible, followed, and kept up-to-date so they can be continued in a repeatable manner if a key relationship manager leaves or if you start working with a new strategic supplier.
  • Use Technology Effectively
    Technology is the great enabler for Supply Management. Use it! Need help finding a vendor? Check the vendor post index and the company directory on the resource site.
  • Enhance Your People
    Train, train, and train … in what other profession can training deliver 10X, 50X, and even 100X returns when your supply managers find ways to take 10% off of multi-million dollar purchases either through better terms or by working with your suppliers to take cost out of the process?
  • Measure the Benefits
    Demonstrate the results, and use this leverage to keep your technology and training up to date and to get more bodies approved to allow you to enhance your relationships and roll the SRM initiative, which will start with a core group of your most strategic suppliers, to more suppliers over time.

Training is Cheap!

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I was overjoyed to see a recent piece in Procurement Leaders that said “if you think education is expensive, try ignorance”. Because, in spend management, where most professionals don’t have at least a decade of experience in every category they have to manage (and often don’t have all the tools and technologies they should have to help them), a lack of training ultimately results in a lack of critical skills and best practices that end up costing many large organizations millions of dollars annually. This is because the potential cost reductions are just left on the table by procurement professionals who didn’t have the skills to identify and negotiate them.

Furthermore, with many courses, and even certifications, available today for just a few thousand dollars, not providing your staff with training at least semi-annually is just ridiculous. (See the training and on-demand resource guides on the resource site for some examples.) Not only is the cost less than 10% of your average salary for a mid-to-high end procurement professional, but it’s less than 1% of the savings that person can generate off of one high-end procurement alone. If it helps them shave another 200K, or more, off a multi-million dollar procurement … it’s paid for itself twenty to one hundred times over. That’s a greater ROI than even industry leading spend analysis and decision optimization can deliver. (Furthermore, only trained professionals can maximize the ROI from these tools.)

So train your people TODAY. And maybe, just maybe, this recession will be the best thing that ever happened to you as your skilled and educated staff helps your organization blow your competition away.

Will Poor Spend Management Be The End of the Ivy League?

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As per this recent article in (of all places) Vanity Fair, Harvard (University), which only one year ago had an endowment greater than the GDP of half of the countries participating in the IMF at 36.9 Billion, may now be on the brink of financial disaster. Between last July and last October, the first four months of Harvard’s most recent fiscal year, Harvard’s endowment lost 22% — a whopping 8 Billion, or more money than Columbia University has in its entire endowment of 7.1 Billion. Furthermore, last December, Harvard’s President warned that a total loss of 30% was expected for the fiscal year (which equates to more than 11.1 Billion) while journalists like Jay Epstein of the Huffington Post argued that, adjusted for the true value of Harvard’s liquid assets, the endowment’s losses were closer to 50% (or 18.4 Billion). Harvard has not yet released its annual financial report, but even though, thanks to a slight economic rebound, losses are expected to be in-line with losses at other universities, in the 23% to 25% range (or the 8.5B to 9.2B range), that’s still a devastating loss.

While it likely won’t spell the end of Harvard, or the Ivy League, it’s sure going to have an impact, one way or another, on the quality of education and life in general at Harvard as faculty after faculty and department after department struggles to implement budget cuts of 20% or more. Budget cuts of this magnitude in any University will generally mean the loss of new facilities and equipment, classes, lab instructors, teaching assistants, and faculty.

So what happened? And what spend management lessons can we take from it?

The vanity fair article had a great summary of many of the actions that likely contributed to the fallout. Let’s review the important ones:

  • Between 2000 and 2008, Harvard added 6.2 Million square feet in new projects that cost 4.3 Billion.
    It also started the Allston Science Complex, now on hold, which came with a price tag of 1.2 Billion. The total expansion price tag represented almost 20% of its total endowment in 2005.
  • In response to this crisis, Harvard sold 2.5 Billion worth of bonds last December and increased it’s debt to over 6 Billion.
    This move, for an amount greater than the GDP of Swaziland, will cost Harvard an average of 0.5 Billion a year through 2038 (according to Standard & Poor’s).
  • (Forgotten?) Interest rate swaps from the early 2000’s that only offered protection if interest rates rose.
    This resulted in Harvard facing an additional 1 Billion loss.
  • It increased its annual operating budget 67% between 1998 (from 2.1 Billion) and 2008 (to 3.5 Billion).
    This is more than twice the rate of inflation, which was roughly 29% over the same period.
  • It increased student subsidies 270% over the last decade, from 125 Million to 338 Million.
    As of 2006, students whose parents earned less than 60,000 a year, a figure well above the median U.S. household income of 50,000, could attend Harvard free. As of 2007, students whose parents earned less than 180,000 a year would pay at most 10% of their family’s annual income in tuition.
  • In 1990, soon after (Jack) Meyer took over financial management at the HMC, Harvard diversified from traditional equity & bond investments into a diversified portfolio that contained pretty much every exotic investment there is.
    Private equity, real estate, oil, gas, fixed-income arbitrage, timberland, hedge funds, high-tech start-ups, foreign equities, credit-default swaps, interest-rate swaps, cross-currency swaps, commodities, venture-capital funds, and junk bonds were just some of the investments.
  • In the late 1990s, Meyer’s best portfolio managers started to leave in droves.
    Meyer paid them based on performance, and in the late 1990s, some of them were making over 10 Million annually. The WSJ got their hands on the story, resentment followed, and the top performers left to work at, or start, funds where no one had to know how much they made.
  • Finally, in 2005, Meyer himself left and it took the HMC almost a year to find a replacement.
    The reduced staff, with no leadership and no particular investment strategy, foolishly continued to invest in the latest, and most glamourous, hedge funds (even though the mania had peaked).
  • Meyer’s replacement, (Mohamed) El-Erian, continued Meyer’s aggressive approach to Harvard’s. portfolio and added even more risk.
    Emerging market investments and tail-risk hedging were two examples of new strategies added to the pool
  • Less than two years later, El-Erian returned to PIMCO.
    It took four months to find his replacement, (Jane) Mendillo — whose recent management experience was a fund twenty-two times smaller.

So what spend management lessons are there to be learned? Lots! But I believe that these are the important ones.

  • One way hedges only work one way.
    This goes doubly true if you’re hedging interest rates. If a shift in the opposite direction can also hurt you, make sure that you either have a second hedging (or swapping) strategy or that you include cancellation/buy-out clauses which you can invoke at the first sign of trouble (and actively monitor for that trouble).
  • Be wary of over-investing in fixed-assets.
    While they look good on the balance sheet, they can eat up a large chunk of your cash flow and cause you problems if your cash flow tightens rapidly. Sometimes you should just outsource (or rent).
  • You need a risk management strategy for your risk management strategy.
    HMC’s financial success was largely due to the visionary and focussed leadership of one man — Meyer — who built an elite team to carry out the strategy. The departure of the leader and most of the core team resulted in the loss of the ability to sustain and manage the strategy, which created a risk much greater than any individual investment. Your risk management strategy must include a succession plan and a blueprint to effectively monitor and continue the activities in the event of the loss of one or more key people until those key people are replaced. Not only must their responsibilities be documented, but so must everything they did, are doing, and must continue to do to prevent greater risk. Otherwise, you could forget to cancel a swap and lose millions (or, in Harvard’s case, thousands of millions).
  • You must control your year-over-year operating budgets.
    If your income is relatively stable and generally doesn’t increase faster than a fixed rate (that can be tied to inflation), neither should your operating expenses. It’s a disaster waiting to happen if your operating expenses (continue to) increase when your revenues decrease.
  • Loss leaders can result in huge losses if you only sell one product!
    Lower prices is a greater way to grab new market share, but it might not be worth it if you have to take a loss on each product you sell. While 10% of the Harvard operating budget for student aid was reasonable in 2008 when the operating budget was 3.5 Billion, it gets expensive if the budget falls 25%! The same holds for your company … if you’re counting on future revenue to make up a new product launch loss, with the fickleness of the market, it might not be there!
  • Don’t get greedy.
    While high risk investments can pay off handsomely in a boom, they can also result in devastating losses in a bust. If you don’t have the money to lose, don’t take high risks. This also means that you don’t switch to an unproven sole-source supplier for a key component when only a handful of suppliers can make the part, that you don’t over-source or sole-source perishable or limited-supply commodities from natural disaster zones, and that you don’t just throw key functions over-the-wall to a new, unproven, BPO.