Influential Sustentation 96: Consortiums

Consortiums, better known as Group Purchasing Organizations (GPOs), will be one of your biggest organizational conundrums of the decade. Regardless of whether your organization is currently using a GPO or not, with the need to save money in every category in your tail spend, the next few years will be the years that you can’t live with them, you can’t live without them.

GPOs are going to be pushed upon you by under-informed CFOs because the believe that a GPO will be able to leverage economies of scale, in the form of more volume and more efficiencies, then the organization can achieve on its own.
For example, a supplier might offer price reductions at 1,000 units, 10,000 units, and 100,000 units and offer 2%, 3%, and 6% discounts at each price level. On its own, an organization that only buys 20,000 units would only be able to obtain the 3% discount but if it banded with five other organizations that required a similar amount of units, each organization could obtain the 6% discount. In addition, if only one contract needed to be negotiated and cut, each organization could reduce the amount of negotiation and administration overhead required to negotiate the contract and save even more. Theoretically.

But all of this comes at a cost. First of all, the GPO has to be funded — so, either the organization has to pay a fixed membership cost every year or a percentage of each transaction. Secondly, the GPO has to be managed just like every business processing outsourcing (BPO) provider. This isn’t always easy because not only does the organization have to manage the relationship and insure that the GPO is working on categories that are important to the organization, but it has to make sure that the GPO is taking the organization’s needs into account. And, the double edged sword, the best deals materialize when the combined volume allows a supplier to hit peak production (which allows them to produce the product at the lowest possible cost) and offer their customers the lowest possible cost. However, getting to peak production often requires combining the needs of a dozen or so different organizations, each of which has its own viewpoints and goals for each category. In other words, while you might prefer Supplier A’s products, because your Engineering department feels that they are of superior quality, the other GPO participants might prefer Supplier X — the least favoured supplier of your organization.

So what do you do?

1. Categorize all of your unmanaged spend.

You need to understand how much spend is each category, how much savings is likely available from (better) management, how much savings you could get if you began to manage it yourself, and how that would compare, using market average GPO statistics on savings and GPO overhead, to having a third party manage it. If you could save 2%, but the overhead to save that is 30%, that’s 1.4% savings at the end of the day. If the GPO can save 3%, and the amortization of the fixed and transaction fees work out to 40% of that, that’s a 1.8% savings, and throwing it over the wall might not be worth it. But if the GPO can save 5%, and they are really efficient on that category and their fees work out to 20% of the savings, that’s a 4% savings and you strongly consider throwing it over the wall.

2. Identify the Candidate GPO spend.

Identify all categories that the GPO could save enough on to make it worthwhile, then remove any categories too strategic to the business to hand over to a third party, and then remove any categories where they are primarily being sourced from a strategic or high-volume supplier and where they could be added on to an existing or renewal contract.

3. Estimate the Realizeable Savings from the Candidate GPO Spend

How much is being spent? How much of that could be saved based on industry average statistics? What would it cost to obtain that savings in total fees and overhead? What would really be saved? What is the real ROI?

4. Determine if the ROI is worth it.

If the ROI is not at least a factor of three, by the time you factor in all the change management, learning headaches, and delayed savings, it’s probably not worth the GPO. If it is, it probably is. Make your decision, and then present the detailed calculation to defend your position, and don’t waffle. If you can save, do it, and evaluate in 3 years. If you can’t, just get the best damn tail spend management you can and do better. But you can’t be constantly evaluating, reevaluating, and bickering about it. Do it. Or don’t. No in-between.

Procurement is Still the Rodney Dangerfield of the Organization and Land of Confusion Is Its Theme Song

Why else would we need an egalitarian Procurement Revolution where we must work collectively to shape and drive change?

But in all seriousness, the numbers don’t lie. If you check out “Five Imperatives for Creating Greater Procurement Agility”, which was recently (and still may be) temporarily free from The Hackett Group, you see that the average Procurement Function Operating Budget is forecasted to increase a mere 1.1% this year. Now, that’s better than last year where it was forecasted to increase a mere 0.7%, but when you consider the average annual US inflation rate from 2000 to 2015 was 2.25% (which you can verify on a number of sites), relatively speaking, Procurement is still getting further and further behind every year!

This is despite the fact that world-class procurement (which needs to be properly funded), has an average payback that is twice that of the Procurement peer group. And, as far as the doctor is concerned, the argument that, since world-class procurement organizations have 18% lower operating costs than the peer group, Procurement doesn’t need as much money, doesn’t pass muster because “operating” costs are different from “capital” costs and might or might not include “training” costs or “travel” costs.

If the organization is doing a lot of outsourcing, then a lot of travel is needed by procurement, engineering, etc. for relationship and quality control site visits, and if all of this has to come out of the Procurement budget, as opposed to the operations budget, that’s not fair. If Procurement is not allowed to spend “capital” to acquire a new system, but must instead use a SaaS solution so it can be expensed monthly under the “operating” budget, while manufacturing and warehousing gets a budget that does not include the ERP upkeep, that’s not fair. If Procurement is subject to the across-the-board training ban, because people should know their jobs when they are hired, and are deprived of the ability to advance their skills, not only is that not fair, but that can be costing the organization millions of dollars as sometimes a better informed and prepared procurement professional can shave an extra percentage point off of a hundred million dollar buy, which makes the 10K it cost to send the person to a 3 day workshop paltry in comparison.

Plus, when sales has to increase revenue by $10 to equal the same savings that Procurement often makes by taking $1 off of the bottom line, it should, logically, make sense to throw money at Procurement instead of the marketing mad men or the house of lies consulting firm. But it doesn’t, proving that most board rooms are still cemented in the land of confusion and Procurement is still the Rodney Dangerfield that don’t get no respect with a kick-me sign on its back.

Navegador Nightmares? It’s Your Own Damn Fault!

In the midst of the recent receivership of Hanjin shipping, the seventh largest shipping line by overall capacity, there are a lot of trepidations, fears, and worries by companies that use it for shipping, and in particular, companies that already have cargo on its ships. (As noted by Bob Ferrari over on Supply Chain Matters in The Financial Shot Heard Across the Globe, many global ports will not accept nor export cargo on the carrier’s vessels because of uncertainties as to whom we pay charges or more importantly, whether specific vessels will be seized by creditors as captured assets, meaning that not only can vessels on the water not be loaded, but they can’t be unloaded.)

Now, if you happen to be working in one of the organizations relying on this carrier, directly or indirectly, you’re probably screaming “how did they let this happen” (where “they” is, in your mind, poor management) and “what the hell do I do now” (and the answer is easy, what you should have done in the first place, and we’ll get to that) and that would be fine, if you were focussed on the right “they” and were simply choosing among your different (pre-planned) disaster recovery options, but chances are it’s the wrong “they” you are focussed on and, as the organization never allowed Supply Management the time to do proper risk assessments and disaster recovery plans, there are no backup plans ready to go.

The short answer is unless you are including yourself in the “they”, as the “they” is all of the Procurement and Logistics managers who not only selected the carrier but encouraged the excessive growth, and unless you are acknowledging that your lack of a disaster recovery plan for this very predictable likelihood (as it’s easy to identify a supply chain choke point and what could go wrong – in this case, all your products in containers on the same ship and that ship all of a sudden going missing, and whether it sinks, gets captured by pirates, or seized by creditors is irrelevant from a recovery point of view), you’re not focussed on the right questions, what you should do about it, and what you should have done in the first place.

Maybe you had little option (as you were shipping from Korea and this was the only reasonable shipping deal you, or your 3PL, could cut), but you could still plan on a lost shipment, have a supplier with excess capacity (in overtime if necessary) that could replace the shipment quick, and a back-up (more expensive carrier) ready to activate if needed (along a different route). This would be okay and proper, especially if you really did need to outsource to Asia, but how many companies did it okay and proper? Judging by the number of articles and semi-widespread panic (and fears of more receiverships and bankruptcies because of the over-capacity, not too many).

But chances are you got yourself into the situation where you had little option, by far-sourcing something you didn’t need to far-source. You got caught up in the outsourcing craze in the 90’s, believed all the hype about lower costs (because of lower unit costs due to weaker Asian currencies, lower wages, etc.), and didn’t look at the full TCO, which also included transportation costs that could be 10X what you were paying when you were near-sourcing from Central America (from the US), skyrocketing T&E costs (because if you didn’t go on-site regularly, you didn’t get what you wanted), and phone-bills that looked like office building lease payments. And maybe if you were in electronics China and Korea had the better factories, but how hard would it have been to invest in new factories in Mexico and Brazil, relocate the necessary top-talent to get them going, and recoup the initial investment in orders of magnitude over a ten to twenty year time-span? Not hard.

Basically, by outsourcing everything you could identify faster than rabbits without any natural enemies can breed, you built up a need for a lot of capacity, which the industry responded to, but when you kept going, the shipping industry, not wanting to get caught with its pants down again, analyzed the trends and kept building. Then, when oil went through the roof, and the smarter companies realized that long-term strategic near-sourcing (and, when possible, home-sourcing) was actually the best option after all was said and done, and pulled back, there was glut capacity and the shippers, who overbuilt, were now stuck with capacity, overhead, and loans they couldn’t pay. This is all a result of poor long term planning on the part of Procurement, and your predecessors, which, in all honesty, you should have been endeavouring to fix as each and every outsourced category came up for re-sourcing (as you should only produce products in Asia for Asia if you can help it — even FoxConn has realized this and opened a Brazilian factory — slow ramp-up not withstanding).

So, whether you created the mess or not, you’re in the job now and it’s up to you to fix it, and the navegador nightmares, the doctor is sad to say, are your own.

Waste Not. Want Not.

Corporate Social Responsibility (CSR) and sustainability is all the rage with Generation Y and, in many countries, is essentially the law (where environmental protection is a key concern of citizens and law makers alike) — but are you doing everything you should (even if it is not yet legislated)?

Basically, if you procure it, and it is not used, you wasted it — and if you are not careful, it will go to a landfill, and that should be unacceptable.

However, in many companies, the focus on CSR and Sustainability is on the supply chain, and the Tier 1 (and Tier 2) suppliers as it is expected the company will comply with all laws and adhere to its own Sustainability and CSR policies, but this over-focus on the supply chain often results in drips of waste throughout the organization that, when added up, create a small pond, if not a large lake.

What do we mean by this?

Due to a lack of initiative or control by Procurement, the following happens in most organizations:

  • paper, paper everywhere especially in the back office (as AP needs to print invoices that fail OCR to re-enter them, legal has to print contracts to review them, managers need their reports on paper, etc.)
  • obsolete MRO inventory piles up in the stock room as excess parts for equipment replaced years ago doesn’t go with the equipment
  • low-cost defective products pile up in the back of the warehouse as it’s not worth the perceived return costs for minimal cost products or low volumes
  • non-recyclable packaging goes to the trash and the local landfills (and dumping costs) pile up
  • broken pallets litter the corner of the yard and are left to rot

But Procurement could prevent most of this.

  • demand management reduces paper especially if Procurement ensures AR, Legal, Managers, and anyone else who generally uses a lot of paper has dual monitor systems. A couple of hundred on a good extra monitor can reduce paper usage by 80% and only has to be replaced every 4 to 5 years.
  • MRO management (software) either in house or third party can instantly detect when inventory is obsolete and sell it to someone who needs it before all it is useful for is scrap metal
  • up-front return process definition and management ensures that defective products get promptly returned, or recycled, to make sure scrap yards don’t increase
  • insistence on reusable or recyclable packaging and making it mandatory in contracts can prevent packaging waste
  • better pallet acquisition can increase lifespan and a recycling/disposal policy can make sure the wood goes to good use

In other words, unless Procurement makes an effort to define its wants as waste free as possible, it will get its wasteful wants. Another point to ponder.