Category Archives: Cost Reduction

Should You Hedge Your Transportation Costs?

It’s a tough question, and one that you need to answer sooner rather than later. If you read this recent article on how “global shipping lines grapple with plunging rates, overcapacity, and faltering recover”, you realize that the global shipping industry is likely in for a very shaky ride over the next few years given the unpredictable demand, the strong likelihood of consolidation, and the big bets some major shippers are making that could intensify the current overcapacity problem.

The following tidbits of information in particular are worrisome:

  • GDP growth forecasts for Canada in 2012 have recently been revised downwards by various analysts to just above 2%
    Canada, which has done quite well in weathering the global economic storm (through better bank regulation, smarter risk aversion, and a focus on natural resources) is barely going to grow. Imagine how the Eurozone and the USA are going to fare in 2012.
  • China growth, while in the high single digits, is slowing
    When GDP growth in the country that houses one-sixth of the world’s population and that is still on track replace the USA as the dominant economic superpower in under fifteen (15) years is slowing, what hope does the rest of the world have for a quick recovery?
  • The dollar still drives decisions. Green is of secondary importance.
    With little incentive to look at new technologies, there is little incentive to look at sustainable solutions that could be more cost effective in the long run. (Such as more efficient engines, on-board solar and wind power, etc.)
  • Maersk, which ordered 10 Triple E vessels capable of carrying 18,000 TEUs in February 2011, ordered 10 more mega-vessels that will cost US $190 Million in late June.
    All of these vessels are bigger than the 15,000 TEU Emma Maersk, which will remain the largest container ship on the high seas until 2013 when the new ships are deployed. But where is the volume going to come from to fill them?
  • Maersk is betting that Asia-Europe trade will increase by 5% to 8% annually over the next four years.
    China’s GDP growth is around 9% and falling. And not all of that is due to trade. The Eurozone is dealing with one financial crisis after another, and no other country in Asia is going to keep up with China.
  • Box freight rates on the Far East-Europe spot market have plunged below zero after stripping out bunker surcharges. Worse, the rates will continue dropping as the big carriers engage in a “destructive” rate war.
    Price wars always have casualties.
  • Net rates are now lower than during the darkest period of the 2009 container slump.
    Rates have no where to go but up (although they may not start rising until we have a few price war casualties).
  • Alphaliner estimates that idle container ship tonnage will climb above 500,000 TEUs by the end of December.
    To put this in perspective, that’s 19.25 Million m3 of idle cargo space which could hold approximately 33.258 Trillion iPad 2’s in the box, if Foxconn could produce them all. (This is 4.75 iPad 2’s for everyone on the planet.)

Put all this together, and you see that:

  • (Some) carriers are going to go out of business.
    It could be yours!
  • Shipping lanes are going to close.
    Carriers will have to drop low volume lanes and consolidate volumes to keep costs down and stay in business.
  • Rates are going to go up.
    As those carriers that don’t go out of business will have no choice to raise rates if they stay in business, even with lane consolidation and elimination of discretionary and low-volume ports.

If you don’t have a ocean freight backup strategy, it’s time to get one, and if a delay could cause you a significant loss or increase in rates as you scramble to divert cargo to a higher cost carrier, it might be time to hedge your bets. the doctor may not be an expert in ocean freight, but this crystal ball is not very hard to read.

Some Takeaways from the E2Open sponsored SCM World Collaborative Execution Study

SCM World recently released a study on “Collaborative Execution” (defined as two or more parties working together to improve supply chain performance by continuously solving real problems with better information), focussed on Speed, Innovation and Profitability, overseen by Kevin O’Marah, and sponsored by E2Open that had some rather interesting, and in a few cases, surprising results. First off:

For suppliers, collaboration is primarily a means by which their customers share demand information, with 73% strongly agreeing this is a key aspect of collaboration.

For buyers, an overwhelming 83% believe collaboration revolves around the supplier sharing availability information (e.g. capacity, lead times, etc.).

In other words, both sides agree that collaboration centres on information sharing and, furthermore, the study also found that,
both sides need visibility and want a dedicated problem solver.

This means that the primary barrier to collaboration between most supply chain partners is the fact that companies struggle to share information effectively, with 54% seeing lack of data visibility across trading partners as a perennial problem. Furthermore, the next biggest barrier was speed of issue resolution, with almost 50% agreeing that this was a barrier to effective collaboration. (In addition, 92% agree that quick problem resolution is part of good collaboration.)

But the most surprising result of the survey was that trust, governance, and benefit sharing were not the biggest barriers to collaboration, as commonly suggested, but the ability to connect trading partner information flow, insure quality of information, and synchronize that information for quick problem solving. (For example, almost one half of respondents felt granularity of data was a problem, speaking to the quality issue, and almost one half of respondents saw timeliness of information as a problem.) This says that, for the most part, it is not lack of desire, trust, or willingness to collaborate that is the problem, but a lack of technology to enable collaboration. (And this is a shame, considering that such technology has existed in more than adequate form for at least five years now for even the largest of multi-nationals with the most complex supply networks. It may take some effort to get used to some of the technology, which is only now maturing on the usability front in some cases, but how much of a barrier is it really to spend a few days learning a technology that is going to cut your issue resolution time in half and decrease your risk substantially?)

Given that:

  • collaborative relationships were more cost effective,
    55% of respondents agree
  • good collaboration minimizes risk, and
    75% of respondents agree
  • learning is faster in a collaborative environment
    70% of respondents conclude that the rate of leaning increases by at least one-and-a-half times

Acquiring the technology that your organization needs to take collaboration with your trading partners to the next level should be a no-brainer. (Especially since the last finding means that any operational metric targeted such as inventory days, total landed cost, cash to cash cycle time can be expected to improve one and a half times as quickly as would be the case without collaborative execution. Thus, any appropriate technology acquisition is going to give you a very quick ROI.)

The only other point of interest was the not-so-surprising result that management by exception it seems is still not part of a “truly collaborative” trading partner relationship for a substantial number of companies. This would indicate that collaboration, even among market leaders, is still not very mature. In a mature relationship, each party trusts the other to do what they do best and only gets involved when a deviation is detected or an idea is devised to improve the process or product. But still, it’s nice to know that both buyers and sellers do not see trust as a barrier to collaborating for mutual gain.

Procurement Game Plan: A Review Part III.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. So far, in our review, we’ve covered the Purchasing Professional’s 10 Commandments, organizational role, Supply Management strategy, talent, social responsibility, strategic sourcing, supplier qualification, negotiation, and supplier relationship management. This post, which continues our review of Part III, dives into procurement performance — measurement and methodology.

If you do not have a solid way of measuring procurement performance, you do not know how well you are doing or, more importantly, how you can improve. If you don’t measure performance, you can be guaranteed that performance, inside and outside your organization, will not be what you expect, and possibly not even to the minimum levels that you contracted for! You’ll have no way of knowing if your supplier understands your expectations, cares, or if your buyers are keeping up their end of the bargain (and buying on contract).

As a result you should keep a scorecard that addresses, at a minimum, the six classifications of procurement impact identified by the authors:

  1. True Expense Reduction / Cost Savings
    When you obtain a true cost reduction and hold volume requirements steady, this is a huge win that is easily understood by all.
  2. Price Reductions that Offset Volume Increases
    If volume requirements increase 20%, chances are total spend is going to go up, but if you negotiated good price reductions, the organization is still saving on a unit basis and the organization must get credit for this.
  3. Expense Reductions through Negotiation
    If the organization did not buy a product or service under contract in the past, but started buying such product or service under contract, then any cost reduction against average historical unit pricing is a savings. If the organization did not previously buy the product or service, then any cost reduction against a market average is a saving (as that is what the organization would be likely to pay, at a minimum, without Procurement’s involvement).
  4. Volatile Commodity Price Reductions Against Market(-Based) Pricing
    There are some commodities, such as crude oil (where the price is essentially set by Wall Street, as we explained in a recent post here on SI), where it is virtually impossible for an average Procurement Pro to reduce cost. Markets drive the prices, and there’s little a Procurement Pro can do. But if the average year-over-year increase is 25%, and the Procurement Pro manages to keep the year-over-year increase to 20%, that’s a win.
  5. Savings that could be obtained with Procurement Involvement
    If Procurement saved 1 Million on 10 Million of spend, that might not be much to an organization that spends 50 Million, but if Procurement was instead allowed to manage 80% of the organization’s spend instead of 20%, then, instead of reducing top-line costs by 2%, it could reduce top-line costs by 8%, and that is a significant contribution that will carry straight to the bottom line [(c) Robert Rudzki]! And if Procurement identifies any areas where it can exceed the average organizational savings percentage, they should be clearly communicated.
  6. Price Increases Incurred
    If Procurement only reports the good, and hides the bad (which will happen from time to time as that Black Swan, who makes Hannibal look like a juvie in comparison, is one nasty little bugger), then it is risking having its reputation ruined when someone in the finance office, bitter about the recognition Procurement is receiving, digs where you don’t want him too. Report the bad. If Procurement is doing its job well, this number is going to be dwarfed by the other numbers and the total-savings-across-the-board calculation is still going to make Procurement look like a star.

The chapter does a great job of identifying, and explaining, the appropriate cost savings formulae you will need to report the above; explaining what a financial performance analysis is; and explaining some key financial terms (such as EPS, EBITDA, and ROI); but the only other section I wish to point out is the section on measuring total team performance that outlines some common mistakes that should be avoided in your reporting:

  • Cost Savings as the Lone Metric
    The first reaction of a skeptic will be what are you trying to hide? As every organization contains a number of skeptics, don’t do this.
  • Not Using Net Cost Savings as Metric
    It’s not how much you negotiate, but how much you capture. That’s why SRM/SPM and spend monitoring (as described in the 100%-free no-registration-required eBook on Spend Visibility: An Implementation Guide) is so vital!
  • Not Taking Markets into Account When Setting Goals
    If raw material costs for steel went up 30% and your product is 60% steel, then your raw product costs have shot up 18% and a 10% year-over-year cost reduction ain’t gonna happen. Don’t expect it!

Remember, it’s all about cost savings credibility. If you have it, your Supply Management organization will get the respect it deserves!

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