Category Archives: Finance

What Competing Agendas?

The following was recently spoken at a leading sourcing conference:

The dynamics and sometimes competing agendas between finance and procurement are widely known.

Huh? What competing agendas? I am on planet Earth, right?

But more seriously, the fact that this myth is continually perpetuated is a serious problem. The reality is that, in a properly run organization, Finance and Procurement have the same fundamental agenda: Reduce Cost. Increase Efficiency. Drive Innovation. The only difference is that, for the most part, Finance is internally focussed while, for the most part, Supply Management is externally focussed. Just like the real goal of corporate finance is to insure that the company has more than enough money to achieve its goals and generate a return for the shareholders, the real goal of Procurement is to insure that the company has more than enough money to obtain the goods and services it needs and generate value for the customers, which, in turn, generates value for the shareholders.

The ultimate goal of any organization is to derive value for the stakeholders — employees, customers, and shareholders alike. Value is more than profit, it’s also sustainability and brand image. For example, if all a company does is produce cheap products that wear out quickly, either it’s going to go broke in warranty costs, or, if the product is not under warranty, it’s going to have a lot of upset customers who are not going to buy again, putting the long term financial viability of the company on the line.

As a result, Finance is about more than cutting costs and hitting budgets, it’s about analyzing the value of an internal spend and determining if the value is there to help meet the company’s goals. If hiring the best people increases that option, then Finance should determine that a higher payroll is the right decision and cost should be cut from somewhere else or, if there are no less critical areas, debt should be secured to obtain additional value, and profit, down the road.

Similarly, Procurement is about more than cutting costs to hit a savings target. It’s about finding the optimal balance of cost and value-add to maximize the overall return to the company. If buying from a supplier that costs 10% more will have a huge impact in brand perception, because either the component manufacturer is well respected and using their name will increase consumer interest or because the defect rate is significantly lower, then the slightly higher cost supplier is chosen. But if it’s a simple office supplies spend, then cost is cut to the low end of market pricing.

And both organizations are trying to find the right balance between cost cutting and value generation to meet the company’s goals and increase shareholder return. Just because Procurement is always spending while Finance is always trying to cut spend doesn’t mean that the departments are in opposition. Finance knows better than any other department that companies have to spend money to make money, it just wants to insure that the money is being spent wisely. And a good Procurement organization has better spending as its ultimate goal. There is no competing agenda between the Finance and Procurement Group, and any organization that thinks there is has a serious problem as they are not aligned, and alignment is become a key to success in today’s economy now that the Old Normal has returned.

Three Things Supply Management Should Know About Real Estate

A recent article over on Chief Executive that outlined six questions a CEO needs to ask the Director of Real Estate is a must read for Supply Management. In many companies, real estate flies below the radar, but often accounts for a significant portion of spend, especially when lease terms are factored in. In particular, Supply Management needs to know:

  • What are our aggregate lease obligations?
    In some companies, only payroll, debt, and cost of goods sold obligations will be greater than lease oligations. For some industries, lease costs will be very significant. Consider the example of how a restaurant chain saved 3.38 Million simply by reducing lease costs at only seven locations.
  • What is our key metric for evaluating occupancy costs?
    In some industries, market rate is irrelevant. What is relevant is whether or not the occupancy costs of the location make economic sense for the location based on actual performance. In the retail and restaurant industry, it’s typically the occupancy costs as a percentage of sales that matter — and these should be below a given threshold. For example, when occupancy costs exceed 10% of sales, there is a greater than 50% chance that the location will lose money. However, if occupancy costs are less than 8% of sales, there is less than a 20% chance that the location is losing money.
  • If our rent is too high, what are we doing about it?
    A signed lease should not deter action. In most instances, a landlord has a strong interest in retaining a tenant and the associated rent cheque. A tenant who goes out of business automatically vacates the premises and voids the rent cheque. Even though it can be difficult to engage a landlord in a lease negotiation, there are strategies, and risk averse landlords will often prefer a smaller rent cheque than no rent cheque for an extened period of time.

Dealing with Price Volatility in the Turbulent Global Marketplace

In the Hackett Group’s recent insight on “Taming the Inflation Dragon”, we find out that the average company is facing a 9% drop in corporate profits this year due to rising prices and other inflationary pressures and that this translates into a 150 Million hit to the bottom line for a typical Global 1000 company with 27.8 Billion in revenue. Ouch!

Obviously, the company is counting on the supply management organization to control costs despite the rampant price increases in a market where commodity inflation has not only increased by 30% overall but where price volatility has increased nearly 60% since before the recession. Not an easy challenge, especially since speculation in commodity markets is having a major impact on 43% of companies and a moderate impact on 17% more. And with the majority of suppliers passing on increased cost, every company is feeling the squeeze. So what can a supply management organization do to improve the situation?

Use rigorous input price/cost forecasting processes
that integrate data from a large number of sources (public indices, private indices, third party market intelligence, etc.) and internal purchase price history. The processes should include years of historical data in the analysis and apply multiple forecasting models to arrive at most likely prices given current trends and models that traditionally work well under similar levels of price volatility.

Augment input cost forecasting with scenario-based business planning processes
that integrate input price/cost forecasts into a pro-forma profitability plan. The scenarios should consider the extreme cases where demand explodes or demand plummets so that the organization can also develop supply risk management contingency plans and estimate their associated costs so that the overall price/cost models are reasonable and capable of being rapidly adjusted if needed.

Employ advanced demand forecasting models
that create good demand forecast ranges to lock down supplier capacity and pricing. Given that one in four companies experiences significant price volatility by having to pull against limited supply, the last thing a supply management wants to do is have to spot buy in a tight market.

Centers of Excellence that use deep predictive analytics
to not only identify input costs that are likely to increase significantly or undergo increased volatility, but to develop detailed should cost models to support negotiations against undue supplier increases, to reduce supply needs of cost-inflated items by changing specifications or identifying alternate materials, and to identify non-price items that can be traded to off-set price increases (such as better payment terms, new business, or supply management support from your supply management organization). Analytics is a key technology for cost reduction and avoidance across the board.

Clear direction and strategy
for hedging and decision making. This needs to start with a cross-functional consensus on what the business objectives are. Is it to “beat the market”, even if it comes at the cost of establishing complex hedging processes? Is it to “smooth” supplier pricing? Or is it to “smooth” margins by the simultaneous optimization of sell-sie and buy-side commercial strategies. Supply Management and Finance must be aligned.

Outsourcing is More Than Throwing It Over the Wall

While outsourcing may be on the rise, it’s still not the holy grail of cost savings. The number of companies that bundled two more or more core F&A processes into an outsourcing deal may have doubled in 2010 (as compared to 2009), but it’s still no reason to rush into one. Even if it is, on the surface, getting cheaper (as the average contract value appears to have shrunk almost 40% since 2004), it will not necessarily save you money. First of all, there has to be money to save. If the organization has a global services unit that is best in class in a process, the organization is not going to save much by outsourcing. Maybe a few percentage points if the organization contracts to a best in class outsource provider that can leverage economies of scale, but that’s it. It is hardly worth the risk of losing the knowledge. Secondly, and this is the usual reality, if the process is broke, throwing it over the wall is not going to gain any efficiencies or savings, at least in the long term.

A recent article in CFO Magazine on how “outsourcing matures, slowly” did a great job of making this point with a quote from Mark Satchel of Skandia, a European investment firm that signed a 175 million dollar multi-year outsourcing deal with HCL Technologies. Skandia hired HCL to develop applications and manage the infrastructure of Skandia’s legacy systems, and absorb 250 of Skandia’s IT employees in the process. While it probably sounded great on paper, as it likely would have taken at least 25 Million in fixed recurring costs off the books, as well as the huge headache of managing legacy systems, which is something an investment firm wouldn’t be an expert in (or want to do), it was a poor decision.

Not only does such a deal “result in a great deal of inflexibility”, as Mark Satchel noted, but it doesn’t address the core issue. The reason that Skandia needed so many IT employees and a sophisticated data warehuse was because it was running on legacy systems. Skandia should have first modernized its systems and processes and then thrown it over the wall. Then, instead of having to go back and renegotate the outsourcing deal to contain the flexibility it needed to serve the “peaks and troughs” of its needs, including the need to update systems, it would have negotiated the right deal the first time. (And “the right deal” would have been considerably less as it’s a lot more cost effective to support new systems than legacy ones.) And Mark would have spent a lot less time wondering whether the gain on one side is lost on the other.

So before you throw that process over the wall, ask yourself:

  1. Is the process (and supporting technology) ready for outsourcing?
    If it’s not, fix the proces (and / or update the supporting technology) first.
  2. What can I reasonably expect to save by outsourcing?
    If only a few percentage points, it’s probably not worth it. If over 10%, then it’s definitely worth pursuing.
  3. What could happen and what flexibility do I need in the agreement to insure I don’t get caught holding the hot potato?
    Flexibile staffing? Variable throughput levels (because more invoices have to be processed over the holidays, for example)? The ability to include additional resources for system updates or replacements at pre-defined costs?

If you do, you’ll be better off.

Ariba Vision 2020: I Hope It’s Just a Ruse!

This post addresses the four predictions in Ariba’s “Vision 2020 – The Future of Procurement” report that were totally off base. SI is not sure whey they came from as they’re not even close to any reasonable expectation of Supply Management reality in 2020.

05. Data predicts the future

Yeah, and monkeys might fly out of my butt!

We will never reach the point where we can be confident that a supplier’s performance will always fall within our customers’ requirements. We will never predict all defects. And we will never predict all disruptions before they happen. Predictive analysis will get better, our value models will get better, and supply chain reliability will increase, but it will never be perfect and never known in advance. Just like we likely won’t see true AI within our lifetime as current approaches just don’t cut it. (And if we do, the machines will realize how inferior we are, and as soon as we forget to encode Asimov’s three laws of robotics into a single robot, we’re doomed!)


Data, data everywhere
and all our minds will shrink
data, data everywhere
sanity on the brink

08. Outsourcing explodes

Actually, outsourcing will suffer a massive implosion as freight costs make moving goods globally prohibitively expensive and exploding labor costs in emerging economies make outsourcing key service functions more expensive than keeping them in-house in major metropolitan centers. What will actually happen is an emergence of Global Service Centers that are part of the organization and employ the right talent for the job at the right locales. Tactical functions will be executed in low cost locales. Strategic functions will be executed where the organization gets the most value. And while some functions will be outsourced to massive third party Global Service Organizations, they will be managed by a Global Service Center that will push out or pull in as market conditions dictate.

10. So long, sourcing geeks
Not by a longshot. While most tools will become so intuitive that even a novice will be able to execute most sourcing and procurement events, there will still be situations where advanced modeling and analysis will still be required and where only sourcing geeks with a keen understanding of the business needs and the strategic analysis required will be able to perform that analysis. While it’s true that the number of sourcing geeks needed may shrink in relative terms, the skill sets required by these geeks will actually increase.

12. Budget fuss fizzles out
As Woody Woodpecker would say, ha ha ha Ha ha, ha ha ha Ha ha, ha ha ha Ha ha, heh-heh-heh-heh-heh-heh-heh-heh-heh! Budget fuss is never going away. Finance drives the business and budgeting is so ingrained in financial professionals that there will always be fuss and muss. While more CPOs will be involved in the budgeting process since day one, they will still have to make their case over and over and over again, no matter how obvious it is.

This ends our review of the 31 predictions in Ariba’s “Vision 2020 – The Future of Procurement” report. Our next, and final, post will discuss the report as a whole.