Category Archives: Market Intelligence

A Quick Introduction to Finance, Part III

A recent article over on CPO Agenda on “Skills for the Future” that summarized the findings from a recent workshop that debated the skills the future would require identified better finance skills as keys to future purchasing success. Since the article simply rambled off a list of terms with no definition, I decided I’d define the basics for you.

Asset Turnover: is the amount of sales generated for every dollar worth of assets. Simply put, it is revenue divided by assets. It measures an organizations efficiency at using assets to generate revenue. The higher, the better. It can also indicate pricing strategy. A company with a low profit margin tends to have high asset turnover, while those with high profit margins tend to have low asset turnover.

Return On Investment: (ROI) is a performance measure used to evaluate the efficiency of an investment. It is calculated as the return on investment divided by the cost of the investment. The higher the ROI, the better the investment.

Return on Invested Capital: (ROIC) is a performance measure used to assess the company’s efficiency at allocating the capital under its control to profitable investments. It is calculated as the Net Return for all Investments divided by the Total Capital available. (Where Net Return is Net Income minus Dividends).

Profit Margin: net margin, net profit margin, or net profit ratio is a measure of profitability that is equal to the net profit (after taxes) divided by revenue. Like Asset Turnover, ROI, and ROIC, bigger is better.

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A Quick Introduction to Finance, Part II

A recent article over on CPO Agenda on “Skills for the Future” that summarized the findings from a recent workshop that debated the skills the future would require identified better finance skills as keys to future purchasing success. Since the article simply rambled off a list of terms with no definition, I decided I’d define the basics for you.

Cost Breakdown: is the process of breaking a cost down into its components.

Cost breakdowns are the basis of Total Landed Cost and Total Cost of Ownership calculations. For example, the cost breakdown of a transformer would be steel, labor & overhead, copper, oil, transportation, miscellaneous components, and supplier profit margin. The total landed cost would be the unit cost, the taxes, the export tariffs, the import duties, and the transportation and in-transit storage costs. The total cost of ownership would also include inventory costs, utilization costs, and waste / defective unit return costs.

Life-Cycle Cost Analysis: (also known as Whole Life Cost) refers to the total cost of ownership over the life of on asset. It starts with the costs incurred in the planning and design phases, includes production related costs such as new machinery or equipment, raw material costs, labor and overhead costs during production, distribution, maintenance, and eventual disposal. From a life-cycle cost perspective, the cost per unit is just one cost among many.

Cost Engineering: is an area of engineering practice concerned with the application of scientific techniques to cost estimating and cost control. It will use advanced statistics and cost models to try and accurately estimate the total cost of a product before it is built and to identify methods to control costs that could increase beyond acceptable bounds.

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A Quick Introduction to Finance, Part I

A recent article over on CPO Agenda on “Skills for the Future” that summarized the findings from a recent workshop that debated the skills the future would require identified better finance skills as keys to future purchasing success. Since the article simply rambled off a list of terms with no definition, I decided I’d define the basics for you.

Working Capital: is a financial metric which represents the operating liquidity available to a business. It’s calculated as current assets minus current liabilities. Positive working capital is required to ensure that a firm is able to continue its operations. Furthermore, it must have enough cash on hand to satisfy operational expenses and maturing debt.

Current Assets: include inventory, holdings, and accounts receivable.

Current Liabilities: accounts payable, debts, and (due) operational expenses.

A key part of working capital management is:

Cash Management: which aims to ensure that the business always has enough cash-on-hand to meet day-to-day expenses.

For example, let’s say that monthly payroll is 200,000, monthly leases are 50,000, and 100,000 in payables are due within the next 30 days. This says that the business needs 350,000 to meet its expenses this month. This also says that, unless payables are received, if the business only has 400,000 in the bank, then it only has 50,000 available for new investments or initiative. As a result, even if you wanted to buy 100,000 in raw materials to negate the need for your supplier to get financing and reduce total supply chain costs, you couldn’t do so. On the other hand, if the business had 500,000 in the bank, you could, but you wouldn’t necessarily want to unless it was the best use of the business’ cash.

Part of Working Capital Management is making the right decisions when it comes to managing cash. This includes making the right borrowing decisions as well as the right investing decisions. If financing your supplier reduced your total cost of ownership of 300,000 worth of goods by 1%, but a short term loan could generate 6% interest, the short term loan would be the better decision. This is because it would generate 0.06 * 100K or 6K worth of interest as opposed to the 0.01 * 300K or 3K worth of savings. On the other hand, if the financing reduced the total cost of ownership of the goods by 3% and the best interest rate was only 4%, financing the supplier’s raw material buy would be the right choice because 9K worth of savings beats 4K worth of interest any day. This is the type of financial planning that Supply Management professionals need to understand to make the right recommendations, and decisions, for the business as a whole.

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Avoid the Five Traps of Performance Measurement

Performance measurement, the foundation of supplier performance management, scorecards, and outsourcing deals, is a key to supply chain success but, like everything else, it has to be done right. That’s why I enjoyed the article on “the five traps of performance measurement” (subscription required) that the Harvard Business Review published late last year. If you avoid your traps, you greatly improve your chances of success.

  • Measuring Against Yourself
    While you should measure against past performance and goals to insure that you’re improving, what ultimately matters is how well you’re doing against the competition. And besides, the historical numbers or estimates could be inaccurate (due to poor data collection or manipulation).
  • Looking Backward
    While you should look at year-over-year performance comparisons, beating last year’s numbers is not the point. The goal of performance management is to insure that you’re making the right decisions and following the right processes now, and not following the decisions and processes that were right for last year (and not now). Thus, you should focus on measures that lead, rather than lag, revenue and profit. For example, a smart healthcare insurer, who realized that the sickest 10% of its members accounted for 80% of its costs, offered customers incentives for early screening because preemptive treatments could save it a bundle and increase overall profits.
  • Putting Your Faith in Numbers
    The numbers are meaningless if they’re not accurate (and include good surveys as well as bad), not anonymous and independent, and, most importantly, not relevant to the goal you want to achieve. For example, the NPS (Net Promoter Score), is only relevant if recommendations play a dominant role in a purchase decision. So while it may be quite relevant to a baby-food manufacturer, it may not mean anything to an electricity supplier. An even better example is the application of financial metrics to nonfinancial activities. For example, to avoid outsourcing, IT, HR, and Legal cost centres often create meaningless ROI numbers.
  • Gaming Your Metrics
    Misguided pressures (billable hours for law firms, reserves for oil companies, security valuations for investment companies) and poorly thought out compensation packages can cause many executives and employees to try and “pad” their numbers to get results which are optimal for them but not for the business, which results in skewed metrics. Also, someone who has learned how to optimize a metric without actually having to perform will often do just that. You have to do your best to insure pressures and incentives align with the goals your metrics are trying to capture and then work with the fact that there will always be a select view who will still try to game the metric anyway. One way to do this is to diversify your metrics (so that they capture different aspects of your goal) as it is a lot harder to gain multiple metrics at once.
  • Sticking to Your Numbers too Long
    As your business evolves, your metrics have to evolve with the business. Before defining your metrics, be very precise about what you want to access and what the success criteria is so that you can not only re-evaluate your metrics in light of the goal on a regular basis, but also instantly recognize if the metrics need to change because the definition of the goal you are trying to measure has changed.

Finally, a really good assessment system must bring finance and line managers into some kind of meaningful dialogue that allows the company to benefit from both the relative independence of the former and the expertise of the latter. And if you avoid these traps, the chances of your performance measurement system meeting this requirement are greatly increased.

But of course, measurement is only the first step. The next step is to use those measurements and transform your way to value. And as I pointed out in my last post, you can start with The Hackett Group‘s current study.

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Purchasing 0.3

Is Purchasing Magazine trying to give me a heart attack? Isn’t it enough that they refuse to acknowledge the presence of Sourcing Innovation (which, as you know, is one of the few blogs that brings you real supply management content you can use day-in, day-out six days a week, every week) which they dropped from their “News from the Web” feed years ago (when I first ripped apart one of their sloppy articles)? After reading a few of their recent articles, my blood is boiling!

That’s right! That bullcr@p that Spend Analysis is expensive (see last Thursday’s post) is just the tip of the iceberg. And even though many of the quoted individuals had good advice to share, in the end, Purchasing’s recent article on “Purchasing 3.0” is just as bad and filled with absurdities … which start on the first line! (If Purchasing had their way, we’d regress to Purchasing 0.3!)

Have you used Social Networking to build supplier relationships?
I Hope Not! Since all Facebook is good for is Facebook parties that result in “Million dollar homes being trashed” (Metro.co.uk) …
If you want to build drinking buddies relationships, yes, Facebook will work great … but what you want is productive and professional relationships where you can work together to make each of your businesses better.

Are you sure you’re using Excel effectively?
You can’t use Excel to manage your supply chain! How many fracking times do I have to say it? Spreadsheets are bad strategy, prevent innovation, and cost you billions! You’re better off using an etch-a-sketch like the dork in It’s All About the Pentiums (2:54 mark). (And just because it’s still all about the pentiums, baby, that doesn’t mean it should be!)

Do you, uh, Tweet?
Are you kidding me? Hasn’t Twitter Turned Too Many Into Twits already? It appears that Twitter has already made twits out of at least 3 in 10 students! The only things that should go “tweet” are Tweety Bird bird and Rockin’ Robin (Muppet Version).

With the prevalence of ERP systems in large companies, more purchasing professionals … should be focusing on developing advanced database skills.
Uhhm, no. Purchasing professionals should be focussed on learning advanced data analysis skills. This is not quite the same as learning advanced database skills. Purchasing managers don’t need to know how to configure, manage, scale, back-up, restore, and replicate databases … that’s what DBAs are for. Purchasing managers know how to use today’s spend analysis tools, which require them to learn how to build and manipulate cubes through dimension-driven UIs, not how to optimize 4 level nested SQL statements … that’s what the tools do! (And frankly, even your average CS graduate would have a hard time optimizing 4-level nested SQL statements across multiple tables, if they could even write them in the first place!)

The article also promotes the new Microsoft Online Services
which will only work if everyone on the team is using a supported version of Windows. And even then, it might not work. (Furthermore, even though they claim that LiveMeeting works on Safari and Firefox on Mac, even if your system meets all the requirements listed, it often doesn’t.) Mac is around 15% of the market and growing, Linux is on the rise (especially in Netbooks), and a number of organizations still use AIX and UNIX based platforms (which could become popular again if thin-client desktops [e.g. SunRays] take off). Not everyone is in the Microsoft eco-system anymore. (And the majority of supply management systems are NOT built on .NET.)

And then the last paragraph indicates that mobile devices are the answer to requisition approval (to keep projects moving), commodity price updates, and procurement communication!
This is probably the most dangerous message of all, because now we’re in Yes, … but territory. Not all requisitions can be approved on a 3×5 screen. What if there are 20 (or more) line items? What if your system flagged 5 as off-contract? What if it’s an unusual request for a significant amount? You’re going to need more data to make the right decision than you’re ever going to fit on that itsy bitsy teeny weeny tiny Blackberry Storm or Curve. It’s one thing to approve a new laptop or mobile phone for an employee that needs it right away to continue working, but another to approve an order of 10,000 units of SKU XYZ123, when the contract is for ZYX321! Why is the order off contract? Oversight? Have requirements changed? Or is your supplier out of ZYX321 and you need an acceptable substitution right away? And what good is a commodity price update if you can’t see the history and the trend graphs. Unless you’ve already done the analysis and figured out that you should buy when it hits 75 or sell if it hits 100, because you’re hedging risk on the commodities markets, that update is useless. And communicating in 140 byte tweets? That would just make you a Twit!

Let me finish by saying that I’m so glad that you, dear reader, are an educated, informed, and intelligent individual who would drop this blog from your feeds faster than a hot potato if I ever published anything as ridiculous as what Purchasing and other publications are getting away with these days!

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