Category Archives: Economics

When you remember Kraljic, don’t forget Coase!

Coase laid the original foundations … Kraljic gave us fundamentals … and now the Busch-Lamoureux Exact Purchasing Framework is building on that to give you a guide to modern Procurement!

The Kraljic matrix is broken. A big problem, as we have regularly explained, is that you can’t compress two independent dimensions (risk and complexity) into one. A little problem is people don’t understand how to qualify the importance of a purchase. It has nothing to do with cost or volume but everything to do with the organizational impact if the product or service being purchased suddenly becomes unavailable. Similarly, it has nothing to do with how much you buy from the supplier, but how critical it is they don’t go out of business. It might be a critical component, but if there are ten other suppliers who can meet that demand for you tomorrow, the supplier is not critical to your organization.

But the biggest problem is that people regularly misunderstand the purpose of the matrix — it was a tool, and the first of it’s kind, designed to get us thinking critically about purchasing and point us in the right direction. It wasn’t the be-all and end-all. It was the first formal methodology an organization had to segment purchases and suppliers, think about them critically, and approach sourcing and supply assurance methodologically. And it was created in a time when global sourcing was more predictable (because natural disasters were a fifth of what they are today, war’s didn’t breakout overnight without warning on the whims of a mad man stuck in a macho cold war colonial mindset), risk was primarily complexity, and if you used the methodology, you probably had a success rate of 90%, which was phenomenal.

Kraljic gave us a way to structure our critical thinking and improve the profession, and all most consultants did was water it down, create a one-size-fits-none methodology, and sell it like it was the next panacea, creating a consulting snake oil from a masterpiece of thought.

A masterpiece of thought you only understand if you understand the framework in which it was built, and those were foundations laid four and a half decades earlier by Ronald Coase in his 1937 essay “The Nature of the Firm“.

The framework was that of organizing the supply management operations of a firm, where the definition of the firm was the one put forward by Coase, which is essentially that the firm was the mechanism by which transaction costs were minimized. (Otherwise, there would be no need for a firm!)

Transaction costs are the result of the price mechanism of the open market, and include:

  • the cost of the negotiation and contract
  • the cost of the individual transactions the contract covers
  • the costs associated with production

and include all of the factors (people, equipment, technology, etc.) included in these prices.

This tells us that the fundamental purpose of a firm is … PURCHASING! And the only way a firm can grow is if it can continue to PURCHASE cost effectively (because as soon as the cost of subsequent transactions and / or production exceed the market costs, the firm is dead).

However, as most firms grew, they reached a point of inefficiency (due to management overhead, process inefficiency, and/or paperwork and/or communication point overload), and growth stopped. Also, as they grew, they became more brittle and sensitive to even tiny disruptions.

Kraljic recognized this and introduced the matrix so that firms could approach their purchasing in a more structured manner that would reduce the brittleness, simplify the management, and allow for additional growth and resiliency. And it was a great start.

But simply classifying items into non-critical, leverage, bottleneck, and strategic misses they key point of the firm’s existence. And that’s to ensure that the costs related to the category are not only always lower than the market cost, but remain low as the company scales.

When you classify an item as non-critical, it becomes ignored tail spend, and we’ve seen time and time again that the average overspend in this category is at least 15% in most companies, with many products and services being bought 30% more over market price.

When you classify an item as bottleneck, you focus on assurance of supply, and don’t dive into determining whether an item is a bottleneck because it can only be supplied by a rather limited supply base or because absence would shut down a production line. (Just because only a few suppliers produce the item to your specs doesn’t mean that only a few can, there might be a few dozen that could, and would, produce it to your specs [at a higher quality at the same price] for a guaranteed mid-to-long contractual commitment.)

When you classify an item as leverage, you double down on price (and exploitation of the price mechanism), and this can often come at the expense of quality and dependability, which can result in higher costs later if warranties come into effect or you have to replace products faster than normal (which always incurs a replacement cost in manpower and opportunity that is never factored into the “we can afford 4 of these per decade vs 3” equation).

When you classify an item as strategic, you triple (or more) the amount of effort you put into the management of that item (or category), and there is a point where the excess time investment not only fails to keep to the associated contract and transaction costs below market, but leads to no additional return on cost investment.

This is because the profiles don’t take into account the separate dimensions of risk and complexity or ensure that “importance” is defined as true “impact”, or provide any mechanisms for determining the impact (or risk or complexity).

This is why you need to go back to the foundations and build up a framework that is capable of capturing what the firm really needs!

That’s what the Busch-Lamoureux framework is intending to do.

By organizing categories based on complexity, risk, and impact

  • the cost of the negotiation and contract is based on the complexity, risk, and impact — where all are low, the whole process can be automated and costs minimized
  • the cost of the individual transactions the contract covers are minimized to verification of only what is important, and humans are only involved when automation can’t do that or finds a discrepancy
  • the costs associated with production are minimized as you are selecting a supplier that meets all of the necessary requirements at the minimum cost subject to an acceptable risk factor!

Furthermore, you’re making your contracts for durations appropriate to the category such that you’re adequately accounting for complexity and risk without locking yourself into long term deals that are not beneficial to your organization!

But most important, because the categorization helps you determine how much manpower you actually need to spend on each sourcing event, contract, and transaction, your organization is much less likely to experience decreasing returns as it grows, allowing it the funds it needs to ensure Procurement is appropriately staffed and resourced with the right systems.

Coase gave us the definition of a firm (PURCHASING)! Kraljic helped us understand the fundamentals we need to consider in our modern world. Now we’re giving you a framework to apply those fundamentals in a manner that will let you scale without fear of unnecessary waste. Go forth and transact! (The market depends on it!)

Another Reason To Avoid AI: NO ECONOMIC GROWTH COMES FROM AI!

A recent study by Goldman Sachs, summarized in Fortune, found no meaningful relationship between AI and productivity at the economy wide level/.

Think carefully about that. 450 Billion, which is more than the GDP of over 100 countries, was sunk (and I mean sunk) into AI last year — for the net result of ZERO economic growth. For 1/6 of that, every college in the US could be free — and you’d have 20 Million smarter adults with no student debt dragging them down, causing them stress, and zapping from their productivity. For 1/12 of that, you could eliminate all the hunger and food insufficiency in the US. For 1/50 of that, you could re-open Alcatraz and provide a King with his own special castle and his own moat.

In other words, there are so many better things that could have been done with that money — including training your people to be more productive, modernizing processes for efficiency, and building deterministic tech that actually works at 1/100 to 1/10000 of the compute power in a data center that’s already powered up.

The only company “winning” is Nvidia, who provides the chips, which means that most of the money is going to its factories in Taiwan and South Korea, and those are the only countries that are actually winning while Americans, who were laid off in droves last year, get poorer, colder and hotter, hungrier and thirstier (as AI sucks up all the energy, which is now not available for heating or air conditioning, and all the water for cooling, which is now not available for drinking or farming).

Think about that the next time you think an overpriced clod or chat, j’ai pété wrapper, even if hyped up as an AI Employee by the A.S.S.H.O.L.E., is going to solve all your problems. Especially since all the Age of AI has done for us is make us dumber, poorer, and less prepared for what is to come next than any age that has come before.

Primary ProcureTech Concern: Weakness & Volatility in Emerging Markets / Trade Wars

Emerging markets are your future markets, and often the source of critical raw materials.

Why?

Given that a lot of outsourcing has been redirected to these “low cost” markets over the past two to three decades, any rapid increase in volatility becomes a significant concern, especially if the markets are not strong enough to weather the storm. A major event could wipe out an entire subset of the supply base literally overnight, greatly increasing supply shortages and increasing the market complexity. Or at least make it unsustainable, such as a 145% tariff on China which is the source of over $500 Billion dollars in imports into the USA.

Impact Potential

The impact of a “low cost” market becoming unavailable, or at least unsustainable, is moderate to severe, especially if all of your outsourced eggs are in the same country basket. One lesson that some companies haven’t learned yet is that dual sourcing is not reducing risk if the two sources of supply are in the same country (or the same small geographic region — because if you have two factories located 100 miles from each other on two sides of a border, guess what, one natural disaster can wipe them both out).

If your primary source of affordable supply is wiped out overnight, it could take months to identify a new source of supply and quarters to secure the supply and get your supply chain flowing properly.

Major Challenges/Risks

Foreign Market Predictions
It’s hard to predict what’s going to happen in a foreign market that you aren’t in everyday. You can follow economist predictions, follow currency trends, try to get a grip on the trade relations between that country and your home country, and so on, but it’s not easy. If you can predict early enough, you can take action. But if an administration, without warning, decides to drop 100%+ tariffs on your source of supply, you’re in trouble.

Alternate Sources of Supply
Sometimes there’s few sources of supply for a given material, part, or product outside of a given country that has a similar total cost of acquisition, especially if you aren’t sourcing at full volume. Identifying alternate sources of supply that you can switch to quickly can be quite a challenge.

New Market Identification
If the emerging market also happens to be one of your primary emerging sales markets, the hit from volatility can be quite significant if the volatility results in rapid inflation, job loss, or both and your sales start to drop rapidly.

Final Words

Given the globalization of today’s supply chains, where a product can depend on materials and parts from dozens of countries, weakness and volatility in emerging markets is a significant concern. And we have yet another (fourth) reason you need an economist!

Primary ProcureTech Concern: Tightening Credit Conditions

The world runs on money, regardless of what form it comes in. Gold, cash, or credit. Credit is particularly important because it helps an organization bridge between cash cycles.

Why?

If economic downturns or inflationary pressures arise quickly, then credit will also tighten.

Impact Potential

If the organization, or its suppliers, needs credit to produce and distribute the goods for sale, the lack of interim credit could lead to reduced inventories and sales and even bankruptcies.

Major Challenges/Risks

Economic Market Prediction:
Predicting whether the economy is going to grow, stay flat, or recess (or depress) is the first challenge, as that’s a leading indicator of credit markets.

Credit Market Prediction:
Based on the projected economic changes, predicting the base and prime rate changes, availability of credit, and the future cost to your organization and your primary suppliers.

Alternative Credit Sources:
If your primary sources are projected to become considerably more expensive or restrict credit access, can you identify alternate sources? Moreover, how much will those cost, how long to establish the relationships, and how reliable will they be?

Alternative Credit Arrangements:
If right now you are just using loans or lines of credit, maybe you need to consider early payment discounts, invoice factoring, or alternative supply chain based credit arrangements.

Final Words

Credit conditions depend heavily on economic conditions, so this is yet another reason you need a good economist.

Dangerous Procurement Predictions Part II

As per our first post, if you read my predictions post, you know SI hates predictions posts. It fully despises them because the vast majority of these posts are pure optimistic fantasy and help no one. Why are the posts like this? Because no one wants to hear the sobering reality off of the bat in the new year and the influencers care more about clicks than actually helping you.

But the predictions are not only bad, they’re dangerous. And to make sure you don’t fall for them and make bad decision based on them, we’re going to tackle some of the most dangerous predictions, which include predictions that look innocuous at first glance (like the last prediction on how a big legacy suite will go out of business) but hide the dangerous consequences of what will actually happen if a big suite finds itself in big trouble. Today we tackle the next four, and you can be sure this won’t be the last post in our series. Feeds are still being flooded with prediction posts, and I’m done ignoring the insanity.

4. The jobs market will be tough for the first half of the year, but will start to pick up in Q3 and Q4.

The job market is tied to the economy, and everyone predicts the job market will rebound when the economy picks up. But here’s the thing. Even when the economy picks back up, the job market never does quite as well as the last time. And the economy isn’t going to magically improve half-way through the year. This is the exact same thing we’ve been told the last two years, and it hasn’t happened.

First off, most of the first world economies around the world are flat, borderline recession, or in recession. Secondly, the only thing propping the US economy up right now is AI, and the money circles keeping it afloat as all the AI, Hardware, and Software companies keep moving the same money around investing in each other to keep each other afloat. If the bubble bursts, the US is in trouble, and the economy will quickly flush itself down the toilet. And the job market will go with it.

Considering only the big tech giants who have been hoarding cash for the last few years are in good shape, and everyone else is trying to conserve cash to survive not only the current market but a potential recession, the last thing they are going to do is hire unless absolutely necessary to fill a critical role as a result of a departure. Remember, they’ve spent the last two years using AI as an excuse to lay people off and are always looking for the next excuse to lay people off, not hire them!

Jobs will continue to be super scarce, and only the best will have a chance to land one.

5. We’re in the early stages of a broader pushback (against unnecessary upgrades or technology investments).

A few companies smartening up and saying no to forced big provider upgrades, eight (8) figure consultancy projects, and big Gen-AI investments is not pushback. There have always been a few leaders who have broken away from the pack, did the math, and made the right decisions, but the pack is still charging ahead on Gen-AI. Every big software shop except IBM (who hired a CEO who can actually do math) has invested heavily in Gen-AI, which still loses four dollars for every dollar of revenue, despite any hopes of a real return in the near future and a 94% failure rate.

Let’s face reality. I warned this space about The Vendor In Black nineteen years ago and how he always Comes Back sixteen years ago, no one took heed then, and no one is taking heed now. The business model of the enterprise software space, which has not changed for the two decades I’ve been covering it, is to solve the problem created by the old sh!t by selling the customers the new sh!t that comes with new problems so they can sell even newer sh!t in three years to fix those (and so on). Same old story. Only the vendor names change.

6. We Won’t Buy Things; We’ll Orchestrate Ecosystems.

This prediction likely came straight from the A.S.S.H.O.L.E. and anyone who repeats it should be ashamed of themselves. There are no AI Employees. Claims to the contrary are false and anyone making those demeaning and degrading claims is simply dehumanizing you. And, as we have clearly explained, you definitely don’t want agentic buying because it will happily spend your money not only on stuff you don’t need but stuff that doesn’t exist and, if you’re super unlikely, stuff that is highly illegal. You need wood, it will buy up all the Minecraft wood because it’s cheap and call your problem solved. And that’s if you’re lucky. If you’re not, it will fulfill your resin need with an illegal purchase of hash (the drug) on the dark web (which is labelled resin so the poster can claim they never advertised an illegal drug). And so on.

Plus, as we have already noted, most of today’s “orchestration” platforms in Source-to-Pay are really ORCestration platforms and can barely connect a handful of major Source-to-Pay offerings. They’re nothing close to what is needed to orchestrate ecosystems.

7. Boards will Zero in on Supply Chain Security and Supplier Risk shifts from quarterly PowerPoints to continuous “signalops”.

Just like they won’t invest more in cybersecurity, they won’t invest more in supply chain security until they lose a shipment in the tens of millions. After all, they’ve got supply chain insurance, why should they care? Especially since their current security measures have been sufficient up until now.

But here’s the thing. When the economy goes down, jobs go down. And then two things happen. People get desperate and turn to crime. And criminals, when their investments in drugs, alcohol, gambling, prostitution, and other quasi-legal through illegal activities start losing money because unemployed people run out of money to spend on their vices, these criminals get desperate too — and high value theft becomes more attractive. A temporarily unguarded truck here. A container there. An entire warehouse. And so on.

If it’s critical raw materials they can move (like rare earths), in-demand finished electronics they can sell (like iPhones, where a single container will contain at least 20M worth), military equipment or weapon (component)s that are now in demand globally, they’ll take bigger and bigger chances, especially if there are weaknesses in security. It’s not just cyber attacks that are going to increase, it’s physical attacks, supply chains aren’t ready, and companies won’t even stop preparing them until they lose tens of millions, don’t recover it all through insurance, and risk losing their insurance entirely. No one likes the math of risk prevention because, when it works, you don’t see the return. Even though it’s so much cheaper than insurance! And that’s why, in the majority of organizations, nothing will change.