Category Archives: Cost Reduction

Procurement Game Plan: A Review Part III.1

Charles Dominick of Next Level Purchasing and Soheila R. Lunney of Lunney Advisory Group recently released The Procurement Game Plan: Winning Strategies and Techniques for Supply Management Professionals. In our first post, we set the stage with The Purchasing Professional’s 10 Commandments. In our second post, we covered the first four chapters of the book that discuss organizational role, supply management strategy, talent, and social responsibility — the stage that a modern supply management professional has to act upon. In our third post, we continued our detailed review with a discussion of the chapters on strategic sourcing and supplier qualification. Then, in our last few posts, we discussed the chapters on negotiation. This post begins our discussion of managing supplier relationships, measuring performance, and improving performance, which will conclude our review of The Procurement Game Plan: Winning Strategies and Techniques for Supply Management Professionals.

The chapter on managing supplier relationships covers a lot of material, but the most important point that it covers is the Supplier Relationship Management (SRM) golden rule: when something goes wrong, blame yourself first. If the supplier was properly vetted, the contract appropriately defined, and the relationship properly managed, the only thing that should cause you a problem is an act of god, an act of nature, or an act of war. Unless something happens that would allow a supplier to invoke force majeure, nothing significant should go wrong. If it does, it is (due to a previous) error on your part. As the authors state do not blame the supplier until you’ve thoroughly investigated the problem and are absolutely sure that the problem was the fault of the supplier because many times the the problem is … the fault of your own organization. (And even if it isn’t, why did you select a supplier who would be so lax? That’s your fault!)

Furthermore, if you consider the primary reasons that most relationships falter, you’ll see that they are all your fault!

  • Unclear Expectations
    Often the performance that you expect is different than what the supplier understands is required. Expectations should be clearly defined with respect to metrics, written down, and discussed with every supplier. There should be no doubt in your mind that the supplier understands what is good behaviour and what is bad behaviour. Failure to insure that this level of understanding is reached is your fault.
  • Opportunistic Behaviour
    There is a certain amount of trust involved in a buy-sell relationship and if the buyer attempts to take advantage of every issue by demanding a discount or other concession (before the problem is thoroughly investigated and the source clearly identified), the supplier will lose their interest in committing itself to help the buyer succeed. Attempting to take advantage of every issue, especially when the cause is likely a lack of expectation setting or supplier management, is your fault.
  • Poor Selection Methodology
    If you ended up with a poor supplier, then the selection process was flawed. Guess what, that’s your fault too!

Now, sometimes it will be the supplier’s fault. Every now and again the shop floor will not have the dedication or interest in pleasing you that your counterpart has, or an executive, stuck between a rock and a hard place when he realizes that the organization overcommitted a certain product or for a certain time window, will decide that you are going to get the short straw, but if you’ve done everything right, this will be the exception and not the norm. And both cases are easily corrected a supplier that wants your business. A heart-to-heart will be had in the first instance (and the people responsible will shape up or be shipped out) and refunds or other concessions will be offered in the second. And the supplier will work with you to make sure it doesn’t happen again.

And if you’ve down your job right, and you find yourself in a situation where a supplier decides not to perform up to expectations and not do anything about it, you already have a multi-stage back up, risk mitigation, and/or disaster recovery plan to fall back on. Starting with emergency meetings and site visits with your counterpart and/or senior management, through third party assistance (such as arbitration or mediation), through termination and a switch to your backup supplier, the recovery strategy and process will be well-documented and ready to spring into action.

The chapter does a great job of covering your options for rationalizing the supply base if things do fall apart, identifying cost reduction opportunities within your current supply chain if they don’t, and the cornerstones of good SRM, which is critical if you want a true supplier alliance, but the only other section we’re going to cover is on minimizing leakage. Once a contract is effected it has to be monitored, carefully, or leakage (which will occur no matter what you do) will increase from a slow drip to a gushing waterfall.

Minimizing leakage in an average organization is, fortunately, pretty straight forward. As the authors note, you:

  • Monitor expenditures regularly
    The biggest barrier to leakage (which can take many forms but typically takes the forms of off-contract maverick buying, over-invoicing, or over-payment) is a watchful eye. Like the watched pot that never wants to boil, a buyer is more likely to stick to a contract when being watched, a supplier is more likely to double check its invoices if being watched, and an accounts payable clerk is more likely to check for duplicate invoices or payments. The simple act of watching (followed by a regular report to senior management on who’s not doing their job) can often cut leakage from 40% to 10%. (And for some great ideas on how to find leakage, why not download the 100%-free no-registration-required eBook on Spend Visibility: An Implementation Guide?)
  • Celebrate and Publicize Success
    Securing an interview with a trade publication or leading blog and having your stakeholders participate not only gives credit and builds ownership of the process, but it instills accountability. Who’s going to jeopardize a savings commitment when the CEO has seen it in a news report?
  • Involve Stakeholders
    In RFP evaluation, supplier survey scoring, and even contract monitoring. If stakeholders feel like they own the process, they are going to do their best to see that it is followed and the savings commitments reached. After all, if they are involved, they are going to share the credit for the success (and that’s ten times better than being blamed for failure, right?).

Our review will continue and discuss the final topics of the game plan — measuring performance, supporting technologies, and your strategy for procurement success.

Procurement Game Plan: A Review Part II.2

Charles Dominick of Next Level Purchasing and Soheila R. Lunney of Lunney Advisory Group recently released The Procurement Game Plan: Winning Strategies and Techniques for Supply Management Professionals. In our first post, we set the stage with The Purchasing Professional’s 10 Commandments. In our second post, we covered the first four chapters of the book that discuss organizational role, supply management strategy, talent, and social responsibility — the stage that a modern supply management professional has to act upon. In our last post, we continued our detailed review with a discussion of the chapters on strategic sourcing and supplier qualification. This post begins our discussion on the chapters on negotiations, and our next post, which will complete our discussion on negotiations, will conclude Part II of our review.

The first chapter on negotiations is on negotiating with suppliers: jockeying for position. This is important, because if your instinct is to take the advice of Meatloaf and “go on the red … go on the green … go on all the colours that you see in between … run all the tolls … run all the signs … run all the way across the double white line” as you jockey for position, you’re doing it wrong. (Peel Out by Meatloaf) The first step — after the issuance of an RFP, the receipt of the responses, and the initial evaluation using a weighted scorecard — is to select which suppliers to negotiate with. As the authors note, if you decided to negotiate with a supplier, than all suppliers who ranked higher must also be negotiated with as to do otherwise would not be ethical (and we’ve already covered how important ethics are).

Then, the authors describe a process for structuring the ultimate contract and this is a good starting point. The steps suggested are:

  1. Identify the best deal for each service/product and term
    Best price, payment terms, warranty, lead time, etc.
  2. Structure the Ultimate Contract on paper
    Based on the best terms available for each service, product, and term, what would the ultimate contract look like? This is the overarching goal.
  3. Decide what could be sacrificed and what an Acceptable Contract Is
    Realize that no supplier is going to be so efficient that they are best-in-class in every service, product, and term and decide what contract would be acceptable. Once this is reached, negotiations can be concluded once you have determined that the supplier will do no better.
  4. Put Yourself in a Confident, Ethical Mindset
    Now that you know what is feasible, you can ask for more from the best / preferred bidder because you know at least one supplier can do it. You don’t have to disclose the supplier (as doing so would be unethical), but you can disclose the best offer you got.

The only thing I would add is create a BATNA – Best Alternative to Negotiated Agreement – that you could fall back on should the negotiations be unsuccessful. This way, you will not be under pressure to cave in to a less than optimal contract AND you have a disaster recovery plan in case the supplier that is selected can not deliver. For example, it could be spot-buying every three months, giving the business to an existing supplier (who may not be best-in-class in those products or services or slightly more costly but a supplier that has proven that it will do what is necessary to deliver), or shifting the production / service delivery back in house.

The next topic that is tackled is structuring payments. There are some great ideas in this section, particularly the one on spreading out big up-front payments (like license fees) over multiple years to insure the supplier has an incentive to keep performing, but the example provided is, unfortunately, very bad!

The example the authors give is that of a three-year contract from an (enterprise) software provider for a license to an enterprise software product, implementation of such software, and three years of maintenance. The authors recommend spreading the big up-front licensing fee and implementation fee over three years, which is a great idea, but suggest that you do this by reducing the licensing fee and increasing maintenance. ACK!!! As an enterprise software professional, this scares the bejeebies out of me! (My initial reaction was ZOINKS!) When it comes to enterprise software, due to the high up-front investment and asset value, once a solution is selected, the enterprise always ends up hanging on to it for well beyond the initial projections. This means that the enterprise ends up paying maintenance fees for years beyond the initial depreciation of the asset. And the way maintenance fees work is that the provider always tries to jack them up on renewal by a good 10% to 20% a year. So if you double, or triple, maintenance fees, then you can expect to be paying those inflated fees for the lifetime of the software as these fees are never lowered. So, if the software was used for six years, instead of three, in the authors’ example, and the organization miraculously managed to hold the maintenance fee flat, instead of having a total cost of $372,000 over six years, your organization can expect a total cost of $492,000 over six years! Consider the following tables:

Three years:

Negotiated Proposal with Up-Front License Fee
Cost Component Amount Payment Due
License Fee 132,000 Upon Signing
Implementation Fee 120,000 After Implementation
Maintenance Fee $20,000 @ start of year 1
Maintenance Fee $20,000 @ start of year 2
Maintenance Fee $20,000 @ start of year 3
TOTAL $312,000
Negotiated Proposal with Modified Payment Structure
Cost Component Amount Payment Due
License Fee 72,000 Upon Signing
Implementation Fee 60,000 After Implementation
Maintenance Fee $60,000 @ start of year 1
Maintenance Fee $60,000 @ start of year 2
Maintenance Fee $60,000 @ start of year 3
TOTAL $312,000

Six Years:

Negotiated Proposal with Up-Front License Fee
Cost Component Amount Payment Due
License Fee 132,000 Upon Signing
Implementation Fee 120,000 After Implementation
Maintenance Fee $20,000 @ start of year 1
Maintenance Fee $20,000 @ start of year 2
Maintenance Fee $20,000 @ start of year 3
Maintenance Fee $20,000 @ start of year 4
Maintenance Fee $20,000 @ start of year 5
Maintenance Fee $20,000 @ start of year 6
TOTAL $372,000
Negotiated Proposal with Modified Payment Structure
Cost Component Amount Payment Due
License Fee 72,000 Upon Signing
Implementation Fee 60,000 After Implementation
Maintenance Fee $60,000 @ start of year 1
Maintenance Fee $60,000 @ start of year 2
Maintenance Fee $60,000 @ start of year 3
Maintenance Fee $60,000 @ start of year 4
Maintenance Fee $60,000 @ start of year 5
Maintenance Fee $60,000 @ start of year 6
TOTAL $492,000

But if you structured it as a three-phase license fee and implementation fee, the costs wouldn’t change. You would end up with something that looks like this:

 

Negotiated Proposal with Up-Front License Fee
Cost Component Amount Payment Due
License Fee 72,000 Upon Signing
License Fee 30,000 @ start of year 2
License Fee 30,000 @ start of year 3
Implementation Fee 60,000 After Implementation
Implementation Fee 30,000 @ start of year 2
Implementation Fee 30,000 @ start of year 3
Maintenance Fee $20,000 @ start of year 1
Maintenance Fee $20,000 @ start of year 2
Maintenance Fee $20,000 @ start of year 3
Maintenance Fee $20,000 @ start of year 4
Maintenance Fee $20,000 @ start of year 5
Maintenance Fee $20,000 @ start of year 6
TOTAL $372,000
Year Total Payments
One 152,000
Two $80,000
Three $80,000
Four $20,000
Five $20,000
Six $20,000
TOTAL $372,000

 

Legal Sourcing Requires A Legal Mind

Or at least an understanding of the legal mind! Sourcing Innovation occasionally covers Legal Sourcing, which is one of the sacred cows in many organizations. However, as the doctor has more expertise in Sourcing Technology than in Legal Sourcing, not very often. Thus, when the doctor sees a great article on Legal Sourcing, he points it out.

Last week, over on Spend Matters, he saw such a great article. Cyndi Joiner’s guest post on how you should “Be Smart When Sourcing Legal” is just such an article. You have to do your homework before approaching Legal, because they always do theirs, you have to understand the landscape, and you have to have a strategy. Cases are built on strategy, and firms that might need to argue those cases are selected on strategy, and if Supply Management does not have a strategy, Supply Management will be shown the front of the door before they even get into Legal’s office.

But if Supply Management has a strategy, they will not only be able to work their way into Legal’s offices, but earn their trust. And when they work with legal to execute strategic sourcing, they will not only get the sacred cow under control, but they will see spend leveraged across the enterprise, standardized rates, documented processes for engaging preferred firms for service, improved billing, and complete transparency and visibility into legal spend. And a sustainable savings average of 7-10%, or more, will be achieved.

To find out how your organization can achieve these savings, check out Cyndi Joiner’s guest post on “Be Smart When Sourcing Legal” over on Spend Matters.

Too Bad the US Post Office Did Not Follow Royal Mail’s Lead

The US Post Office is in dire straits. So dire that, as per the transcript of this PBS.org Newsmaker Interview from December 5, 2011, on how the “U.S. Postal Service Faces Big Changes Amid [its] Struggle to Deliver on Profitability”, the post office is planning to shutter almost half of the nation’s mail processing centres next spring. Given that it is currently 15 Billion in debt and owes about 5 Billion for retiree health benefits, it needs to save 20 Billion fast and it’s solution is a significant restructuring that it hopes will allow it to save 2 Billion next year and 20 Billion by 2015.

This is pretty drastic, and we’ll talk more about it in a bit, but it’s also surprising given that it’s counterpart across the pond, Royal Mail, at the same time, was discussing the results of its first major Procurement Transformation in “Special Delivery”, which ended in 2009 and saved 300 Million pounds. This was followed by a cost management program that doubled the savings number about a year later, which led into a second major transformation project, currently underway, where Royal Mail expects to save significant dollars yet again. 600 Million pounds, or roughly 1 Billion dollars, is very significant when you consider that the Procurement organization only influences about 1.7 Billion pounds of spend out of the 2.3 Billion pounds spend by Royal Mail. That means that, in roughly a 4 year period, as the transformation initiative was only announced in 2006, the organization averaged about a 9% savings a year in the public sector where it is under tight public procurement law, compliance, and regulatory demands. When you think about it, this is an absolutely amazing result.

In contrast, the U.S. Postal service is projecting a 14 Billion loss this year if it does not get legislative relief. 14 Billion! (Note that last year’s budget gave them 11 Billion legislative relief! Source: Red Dog Report (“obama budget includes 11 billion post office bailout”) And that this year’s budget is recommending another 11 Billion in relief. Source: Washington Post [postal service on tap for 11 billion bailout]) And this is the tip of the 238 Billion budget deficit it is predicting over the next decade if it doesn’t cut costs. (Source: United Liberty [united states postal service faces 238 billion budget deficit]) Given that it’s annual budget is about 68 Billion, based on expected Revenue for 2011, this represents a 20% loss! While Royal Mail was saving 9%, the US Post office was losing 16%, on track to lose 20% this year (and, based upon the projection of a 238 Billion deficit if nothing is done in 10 years, probably 30% plus in a few years).

Now, it’s tough when you have to deal with a drop in regular first class mail that amounts to 27% when compared with volume levels 10 years ago, especially when that is your primary source of revenue, but this drop was visible years ago, and efforts to reduce costs could have been underway years ago. The network should have been optimized 6 years ago, re-evaluated, and then optimized again last year. And, like Royal Mail, which was also dealing with increased competition and revenues declining at 5% a year for similar reasons, it should have focussed on vehicles and operations, business services, facilities management and property, IT and telecoms, and sourcing and demand management to do what it could to keep costs in line as much as possible year over year. Since network reorganizations of the type that the U.S. Post office has to undertake can take years, some losses were unavoidable, but this blogger finds it hard to believe that 14 Billion in losses were unavoidable. And, like Royal Mail, it should be making a hugh effort in Supplier Performance Management to help suppliers keep their costs down.

However, the most fascinating fact that is overlooked in all the news reports is the lack of focus on Supply Management. Back in 2007, the U.S. Postal Service licensed CombineNet’s advanced sourcing platform. While for years this platform, in the doctor‘s view, had usability issues in that self-service just wasn’t an option for most organizations, as per SI’s extensive coverage on CombineNet back in 2006/2007, when they were undergoing their first major transformation of the decade, this was one of the most powerful strategic sourcing decision optimization platforms on the planet. If the U.S. Post Office was properly applying this platform, the doctor believes they should have been saving money hand-over fist. After all, Royal Mail used Iasta, which only introduced its advanced sourcing platform in the 2007 timeframe, about 7 years after CombineNet, and saved big-time. (Note that this is not a knock against Iasta, as the platform they introduced was rock solid, but an attempt to make a point that the platform CombineNet had was seasoned and powerful enough to do what the U.S. Post Office needed it to do, including re-optimizing the entire U.S. Post Office service network.)

Supply Management can save just about any organization, but the organization has to be willing to use Supply Management, and the tools and techniques Supply Management brings to the table, and used Supply Management aggressively if the organization is serious about staying above water.

Can Cost Management On Its Own Be Strategic?

A recent issue of eSide Supply Management published a piece on “Strategic Cost Management and the Supply Base” that, while full of good advice, might be misleading to an up-and-coming Supply Management practitioner who needs to be set on the right road early on. However, before I can explain, let’s review the key points from the article.

The article started off great when the author noted that:

It might sound obvious, but when faced with a cost improvement challenge from your business, a good place to start is to think about what you’re practically being asked to do. Does the scope of the request apply to an innovative product or service whereby you more likely need to achieve an optimized cost, while simultaneously trading off against other attributes such as performance, delivery channel or customer appeal? Or, is the focus on a current product or service which is no longer deemed competitive or requires maintenance of a current selling price via cost reduction efforts.

The reality is that cost management is not simply keeping prices down. It’s keeping total cost down — where total cost is the total lifecycle cost of the product, which includes acquisition, manufacturing, distribution, sale, warranty, return, and disposal — while keeping total value up — which includes quantitative factors such as low defect rates and high reliability and qualitative factors such as market appeal and differentiation. And the best way to achieve this goal will be different for every product.

And the goal will always be cost, and not price, reduction, because cost reduction is typically sustainable over the long term, while price reduction is often a short-term commercial concession, which is then typically reversed later when the power balance in the buyer/supplier dynamic changes.

However, cost reduction is a more difficult task, especially when the suppliers have power, but there are tools available to help the buyer. The author does a good job of pointing out some of them, including:

  • analytics and benchmarking
    which can provide a buyer with a detailed cost breakdown and a foundation for an accurate cost (of production and distribution) model — which helps the buyer understand how much it should be costing the supplier and what level of profit margin the supplier is trying to get
  • integrated product teams
    whose collective understanding of the product or service from a production, distribution, use, and repair and recovery perspective can shed insight on potential opportunities for cost reduction that a supply manager may not see on his own
  • supplier involvement (from a technical perspective)
    a good supplier is full of innovative ideas to provide your organization with more value (and keep you as a customer) — especially if you bypass sales and go straight to the product engineers or service professionals (as they know where the cost is)

But even though this will help with the multifaceted, complex and often perplexing arena of supplier cost management that supply management professionals have to deal with on a daily basis, it kind of misses the full picture — that cost is only one component of strategic supply management and if supply is strategically managed, cost will fall in line as the buyer will know what costs need to be managed and what costs (of little consequence) can, more-or-less, be ignored.

After all, it’s usually not the initial price that constitutes most of the cost, but the unexpected expedited deliveries, the unexpected high rate of failure and warranty returns, the cost of unhappy customer retention, the losses associated with inventory stock-outs because the supplier couldn’t deliver on time at all (even with expedited deliveries) that constitute most of the unnecessary cost in a category. Control the supply, control the cost.

Thoughts?