Category Archives: Cost Reduction

You’d Think It Would Be Obvious By Now that You Should Not Poison Your Customer

After the plethora of lawsuits filed in 2008 against Sanlu Group for putting melamine in the milk (or, to be precise, a baby formula that was based on milk) as per this article in the New York Times, against the individuals responsible for importing rip-off toothpaste (that was not manufactured by Colgate) contaminated with diethylene glycol (which is a sweet tasting poison used in anti-freeze and which kills poor defenseless LOLCats), and against Mattel for importing toys coated in deadly lead paint (as per this article from USA Today), you’d think that even if they were run by sociopaths without any ethics whatsoever, corporations focussed on the bottom line would know better than to poison their customers.

However, after reading Pierre the maverick Mitchell’s Friday rant which was “an open call to hotels to NOT poison their customers”, all I have to say is, apparently not!

Maybe they don’t know they’re doing it, or they do but believe that the average customer doesn’t stay often enough or long enough to be exposed to enough toxins to be damaged. Now, this might be the case for the average person who only uses a hotel once or twice a year on vacation, but what about the travelling salesperson or executive who spends more time in hotels than in their own home? How long before BPA builds up to toxic levels in the bloodstream, given that a new study has determined that your body absorbs more BPA than previously thought (rodalenews.com)? If the coffee maker and plastic stir sticks that you use to make your coffee every day leaches BPA, how long before you are sick, whether you realize it or not?
And that’s just the tip of the iceberg! According to Pierre, the non-dairy creamers many hotel chains provide are full of toxins — sodium caseinate, monoglycerides, and diglycerides. We might as well eat glue!

It’s scary. And the worst part is that the cost savings the hotel realizes from buying cheap coffee makers, non-dairy creamers, and other toxic products are negligible. Compared to the revenue a hotel chain can see on a nightly basis from a quality offering that puts them ahead of their peers, a few pennies of savings versus a few dollars in profit is not only negligible, it’s just stupid!

Why TVM Optimizes Spend

Procurement needs to generate value. But Procurement is usually evaluated on savings. It’s a disconnect, but one that needs to be addressed. The best way is to start in the middle. What is the middle ground? Spend optimization. What’s the best way to optimize spend? Focus on total value.

When one focus on total value, one simultaneously optimizes

  • Total Cost of Ownership (TCO)
  • Customer Benefit and
  • Indirect Value Creation

which are the three occasions where one should spend more as per Spend Matters’ UK recent piece on “Three Occasions When Procurement Should Spend More”.

How does one focus on total value? One starts with the definition of Total Value Management as given in the e-Sourcing Wiki Paper on Strategic e-Sourcing Best Practices. In this classic wiki-paper, Total Value Management (TVM) is defined as a comparative cost metric that quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization’s sourcing strategy and supply chain goals.

In other words, TVM not only maximizes the net benefit between the return curve and the cost line, which is computed during a calculation of indirect value generation, but identifies the cost line and associated return cost among all possible cost lines and their associated return curves that allows for the largest maximum net benefit. In other words, TVM does a Pareto optimization and identifies the maximum benefit to the business. Since cost is optimized relative to the return, not only is TCO optimized but the organization has saved as much as it could because any attempts to spend less would result in more dollars being spent somewhere else.

And when we review the three occasions where one should spend more, we now know that

  • TCO is directly optimized because it has to be to compute the cost line,
  • customer benefit is indirectly optimized because the return is only optimized if the activity results in more customer sales or more revenue per customer sale and
  • indirect value creation is directly optimized because marketing, services, etc. spend will be optimized under this model.

Procurement Trend #08. Lifecycle TCO

Five anti-trends remain. We can count them on one-hand, but like LOLCat, we feel more compelled to provide stupid examples of how back-water the futurists really are when they provide us examples of trends that anyone who bothered to poke their head over their cubicle wall ten years ago would have noticed. However, we’ll leave their humiliation for LOLCat, who has obviously received very little enjoyment from this series, but still found time to point out how LOLCats have been sustainable at least since the first corrugated cardboard box was created and instead focus on blasting the myths the futurists continue to propagate.

So why do these Rip van Winkles keep pushing upon us trends from yesteryear? Besides the fact that some of them obviously spent the best part of the last few decades napping, probably because they look around, see the laggard organizations still caught in the muck, and assume they can still sell last decade’s snake oil in today’s marketplace. Why do they think Lifecycle TCO is today’s cure?

  • the supply management lifecycle in a typical company has been expanding
    for decades

    and cost models rarely keep up

  • once the margin has been taken out of the unit cost and the landed cost,
    the definition of cost has to expand to realize savings

    but most companies that claim to be looking at TCO are still looking at T-CAP

  • the most out-of-control costs are typically where you’re not looking

    and that’s the way, uh-huh, uh-huh, they* like it

So what does this mean to you?

Cost Models Have to Expand

Right now, most companies that claim to be focussed on Total Cost of Ownership (TCO) are really only focussed on Total Cost of Acquisition and Production (T-CAP). They are merely focussed on landed cost and costs associated with production (waste, etc.) and distribution and aren’t looking up the supply chain to energy, labour, and raw material costs and forward to maintenance, service, warranty and return costs or even further forward to reclamation, recycling, and disposal (related) costs. Every cost has an impact and any sudden increase or decrease can completely change the model.

Out of Control Costs Have to be Found

Wherever they are. Typically, a company heavily focussed on optimization will be focussed on T-CAP but not look at the expected warranty and return costs associated with switching to a lower-cost supplier or not break down the supplier’s quote to realize that the energy costs are much higher than expected and likely to rise rapidly in the region two potential suppliers are currently located in.

Cost Control Measures Have to Be Implemented

Once the cost models are expanded, the out of control costs are identified, cost control measures are defined, implemented, and performance against them is tracked. If the out of control costs are energy costs, then the organization might decide to implement its own renewable power plant (such as a solar farm or wind farm) for fixed plant energy requirements. A sourcing project is undertaken to source the plant and then, once its up and running, additional projects are undertaken to control maintenance costs, etc. Year-over-year costs are tracked to insure the realized savings on a production-cost-per-megawatt basis are realized so that the organization will see its ROI within a defined period of time.

Piece of Cake, eh?

It’s Conference Season, and that means It’s Travel Season! Part II

And this means it’s time to get your T&E under control.

Since what gets measured gets managed, this means that the first thing your Supply Management organization should be doing is measuring the spend. In particular, it should be measuring:

  • How much spend is under management,
  • How much spend should be under management,
  • How much spend is being spent on each T&E category,
  • How much spend should be spent on each T&E category, and
  • How does the T&E spend compare to business norms?

Why? Let’s take these one by one.

How much is under management?

Supply Management success comes from spend under management. If the majority of spend is not under management, then there is a huge untapped opportunity that comes from getting the majority of spend under management. With enough centralized spend volume, leverage can be used to negotiate better airfares, hotel rates, and car rentals — which may take the form of increasing rebate levels as spend volumes increase.

How much should be under management?

While the goal for most categories is 100% Spend Under Management, T&E is one category where the goal should never be for 100% under management. Why? Taxi and limo companies are different in every city, trains are usually localized to a given country, and while McDonald’s is doing its best, there is no truly global restaurant chain with an establishment in every country. You only want to manage those categories where there is enough spend volume to get leverage and where there are vendors that can meet a significant percentage of global T&E needs. In other words, airfare, hotel rates, and car rentals. For the rest of the spend, you want to set policies that have acceptable ranges by locale. Specifically, you want a range for each country, each state where the averages are off more than 10% from the country, and each city where the averages are off by more than 10% from the state. For example, you wouldn’t use the US average for a 3 star hotel or a dinner in New York, New York, USA or in Pueblo, Colorado, USA where the average cost of living is significantly higher than the norm and significantly lower than the norm, respectively.

How much is being spent on each T&E category?

This information will be critical to negotiating agreements with vendors that will save the organization money in the long run.

How much should be spent on each T&E category?

Before the Supply Management organization begins negotiations with prospective vendors, it needs to understand how much it should be paying. For example, before negotiating with a major airline, it needs to research average fares for its most common travel itineraries, average discounts or rebates for the spend volume it has, and other factors that make it a desirable customer for the airline in question.

How does the T&E compare to business norms?

Specifically, how much is each department spending on T&E relative to the industry norm for that department (measured as a percentage of budget or other standardized measure). If Sales is spending more on T&E relative to the industry average, then either it is traveling more than its peers (and this means it should be getting better results to warrant this travel, and this is up to the VP of Sales and the C-Suite to decide) or it is traveling the same amount and spending more, and this means that its costs are too high and Supply Management either needs to help it get better rates or implement better policies. Regardless of the situation, Supply Management needs to present the T&E spending facts to the C-Suite for every department in the organization so that it gets the authority to do what it needs to do to bring more SUM and so the C-Suite can decide whether any department spending more than industry norms (for its size) has a valid reason for doing so.

And finally, as explained in detail in Part I, despite urges to the contrary, neither Finance nor Supply Management should be attempting to judge the ROI of business travel by function, as suggested in this post over on CPO Rising, or try and measure it with a quantitative metric. It’s job is to prevent over-spending, not to question the validity of the spend. That’s for the head of each department and the C-Suite to debate.

It’s Conference Season, and that means It’s Travel Season!

And this means it’s time to get your T&E under control.

Since what gets measured gets managed, this also means that the first thing your Supply Management organization should be doing is measuring the spend. Then, when it has measured the spend, it should be evaluating the spend. If the spend is too high relative to industry norms, then it needs to get the spend under management as soon as possible. However, one thing it should not be doing is questioning the validity of the spend.

What do I mean by this? Simply put, neither Finance nor Supply Management should be attempting to judge the ROI of business travel by function, as suggested in this post over on CPO Rising, and they definitely should not be trying to measure it with a quantitative metric.

Why?

Simply put, outside of their respective domains, these organizations have no clue how valuable or invaluable a sales meeting, training session, or conference was, and sometimes even the VP who approved the spend doesn’t know, because the value from the travel typically cannot be measured in the short term. And there definitely isn’t any way to predict the value beforehand! In the CPO Rising post, the author gives the example of Sales and says you should ask if the sales team closed a deal as a result of an expensive trip or if IT has improved its processes by attending specific conferences. These are both WRONG questions.

In the Sales example, in traditional enterprise sales with traditional executives (who have been in their roles for 20+ years), not every trip is going to close a deal, or even have a directly measurable impact. Sometimes multiple trips are required by personnel to build a relationship, which must be built before a deal can even be negotiated as relationships in many South American and Asian cultures must precede a business deal. With this metric, the salespeople would never take a trip, never meet new potential clients or business partners, and never close any deals!

And the author of this CPO Rising post, who has obviously never been an IT guy*, needs to understand that sometimes where conferences are concerned, process improvement is not the point. Sometimes the whole point is to give key members of the development team who have been working their asses off for months straight on a key project a reward and a break (for burning the midnight oil on a regular basis and doing whatever it takes to make an unreasonable deadline set by Maury the Management Moron). The whole point is to keep the key team members happy, boost morale, and expose these team members to new ideas that will help them identify the technologies and processes they should be researching on their return. Because, where IT is concerned, it’s not how many warm bodies you have in front of computers, it’s how skilled those bodies are. In a discipline where your top coder can be as much as 20 times as productive as your average coder (because you have too many poor performers and not enough superstars), quantitatively measured in bug-free lines of code, and where top talent is rare, the organization has to keep its top talent, and low-cost tokens of appreciation, like conferences (that will also open the developers’ minds and embark them on a journey towards even more productivity in the future) is a great way to do it. If you’re going to cut the travel budget just because there’s no immediate return, then you might as well lay off the top 20% of performers in your organization, get a shotgun, blow a hole in the server, and see how you fare. Because that’s effectively what you’re doing if you don’t have another way to keep morale high in IT.

So what should an organization be measuring, evaluating, and managing in terms of T&E spend?

Come back tomorrow for Part II to find out.
* Unlike the doctor who has a PhD in CS and who has been a senior algorithm developer, enterprise software architect, research scientist, and CTO …