Environmental Sustentation 20: Oil & Natural Gas

Oil and Natural Gas is an environmental damnation in more ways than one. It’s dirty fuel, that is regularly subject to price shocks, and it’s collection and transport often result in significant disasters to the environment, your bank account, and your reputation.

And even though you should move to greener power, in some cases you can’t. Biofuel is not always a viable alternative for transportation, especially for ocean freight (where it takes a lot of combustion to move those mega-carriers) or air travel. And you still need to power your current energy production systems until the new ones come online. So you are stuck with using oil & natural gas for at least some of your energy needs for the time being. (But hopefully with a plan to use less and less over time.)

And, as a result, have to live with the risks of shortages, price spikes, disasters, and the resulting financial and reputational damage that will result. So how do you survive?

Accurately predict future needs.

If your demand is going to spike because of expected sales spikes, or projected energy shortages in other areas, that is something you want to know in advance so you can be sure to contract for sufficient supply. Similarly, if demand is dropping, that is also good to know as maybe you can cut shorter contracts and buy more on the spot market without serious repercussions.

Acquire expert supply and price projections — from various sources.

Don’t just monitor supply and prices, try to understand where it is going so you can source, or re-source, at the best times. While an unexpected disaster, political decision, or pumping slowdown can change everything, the more informed you are, the better off you’ll be.

Have disaster recovery plans in place.

If there is a shortage due to a disaster, you want an alternate source. Don’t sole source if you can avoid it, and make sure you include a provision with the provider who gets the smaller award to increase business over time and that they can support a spike if you need it. If there is a transportation disaster, hopefully you don’t take possession or responsibility until it’s in your storage tank, but either way, you better have a plan to get another shipment sent through an alternate carrier, possibly from your other supplier, ASAP.

Start sourcing clean power and building your own power plants.

Most places in the world can produce a lot of power from wind, solar, or hydro-power, and not only should you be looking to buy from energy companies that produce this power, which can power your equipment, buildings, and even short-haul transportation (that run on battery packs), but if you are a large factor or office building that uses the equivalent of a small power plant of energy, you should be building your own, and only taking off the grid when you need supplemental. With so many regular failures in overtaxed and antiquated power grids, this is just good planning.

While we can’t rid our dependence on oil and natural gas just yet, we can certainly reduce our need for it and this type of planning will not only make it more affordable (if demand lessens), but also make energy consumption and transportation safer and more reliable.

Category Aggregation – How Far Do You Go?

Category Aggregation is one of the tried-and-few methods for spend leverage in Procurement — aggregate a bunch of items, go to market simultaneously, and demand big discounts for big awards. The first time a significant category of significant size is aggregated, and offered up, the organization will see savings … often significant savings.

But does the spend have to be aggregated to get the savings? Let’s examine the likely reasons why a supplier will offer up savings.

  • They were making a fat margin and could give it up.
    For example, maybe a healthy margin for the industry, unbeknownst to your organization, is 10% and they were making 15% (because of internal efficiencies or collusion that prevented you from knowing the true margin). In this case, they would be happy to sacrifice 5% to triple their business.
  • What’s lost on unit is made up in volume.
    If volume allows them to not only maintain their profit level but potentially increase it, they are likely to go for it.
  • Big orders allows them to get discounts on raw materials.
    Smarter suppliers may realize that the more volume they can commit to, the better prices they are likely to get and offer discounts based on projected cost savings on raw materials.
  • Big orders allows them to operate more efficiently.
    Some suppliers might have plants that operate most efficiently at large volumes, and will take slight margin cuts to maintain peak production level (and enough cash flow to pay the workforce without expensive “payday” loans).

If you look at these reasons, it would seem that the best way to get better savings is through aggregation as this is the only way to make the buy more enticing. But is it?

Not necessarily. Let’s start with the fact that suppliers might be willing to give you price reductions if they get price reductions. You could always give them price reductions from the get go by buying raw materials your organization uses a lot of across categories at prices better than smaller suppliers could get and, as part of every bid, noting that they will have access to necessary raw materials at a reduced cost when serving your organization. They can pass this savings on to you as part of their bid.

You can also engage your best engineers and production consultants to create detailed should cost models that take into account market pricing on raw materials, labour rates, energy costs, and average production line maintenance costs, tack on a fair margin, and use this information as leverage in negotiations in conjunction with open book costing requests. You can ask not only for a price breakdown, but compare it against expected prices and see which suppliers are trying to keep the wool over your eyes, eliminate them, and work with those focussed on win-win cost reductions. (You’ll allow them to maintain a healthier than average margin if they cut your costs by using your lower cost supply, optimizing production runs, and implementing the lean process improvements you dictate.)

You can guarantee them a certain revenue in the following year if they meet performance targets. (For example, if they maintain an on-time delivery of 90%, a defect rate of under 2%, and costs are maintained, in 12 months you will guarantee their annual revenue will increase by 50%.) Now, you might think this is hard to do, but with an optimization-backed sourcing platform, you can dictate minimum award requirements in a scenario, or determine impact across a set of scenarios, and pick the categories where an additional award will most benefit your organization.

You can allow them to specify optimal order sizes based on their factory. For example, if they produce 10,000 units a day, you should order multiples of 10,000 at a time — otherwise, they might have to switch dies, etc. during the day and take down the production line while staff are still on the clock. Tying order sizes to production runs means that they only have to reset the production line once a day, before or after a shift, and the supplier can keep their overhead down.

Aggregation is not always necessary, but sometimes it does make sense. Why do three sourcing events for essentially the same product or service? Especially when you can do one, implement one or more of the above strategies, and potentially identify more value than your peers. In other words, you should aggregate when it makes sense, and be aware of the “6 Critical Success Factors for an Aggregation Approach”, as summarized by the public defender, but not depend on this strategy or overuse it.

Platforms are Needed to Accelerate Procurement Agility – But Don’t Overlook the Offline Contributions

Over on Spend Matters UK, the public defender wrote a great post on “Why Platforms are Needed to Accelerate Procurement Agility” and discussed how the digitization of our everyday lives through cloud-based services served up over the internet is arguably the single greatest consumer trend of the modern era. In this post, he noted that the digitization trend has also worked its way upstream into B2B value chains and since businesses don’t want to be “digitally disrupted” by others they are searching for new supplier capabilities they can serve up as new customer-facing services.

This is a great use of digitization capability where it makes sense, but it’s not just online agility that is needed, it’s offline too. And this is where modern platforms can make the most impact.

Consider the NPD/NPI lifecycle. Right now, what typically happens is engineering works in their own little world designing a product, and when it’s mostly done, they contact procurement to help them find sources of supply and qualify their preferred manufacturing houses. This is typically done in CAD/CAM software, disconnected from everything, and can be a slow process.

Initial design might have to be slow, but the fact that its disconnected can really slowdown the NPI cycle. If design is not plugged in to the rest of the enterprise, and Procurement cannot be involved from day one, the engineers might choose discontinued parts, work with unfavourable suppliers, or even work on features that are not desired by the majority of current customers.

Then there is sourcing. Without advanced knowledge, Sourcing will not only need ramp up time to identify sources of supply, but might be stuck trying to source materials in limited supply that have a locked in price higher than the organization can afford if it wants to meet cost targets. Early involvement can help Engineering understand where the cost is and select the right design options when it has a choice.

Then there is inventory and manufacturing planning. Procurement needs to be plugged into marketing and sales to accurately estimate demand, and have to be in tune with supplier production capacities and shipment times to make sure orders are placed on time and stock-outs can be addressed quickly in times of demand surge.

The only way NPD/NPI time can be minimized is if the process goes smoothly. The only way this can happen is if Procurement is involved from the beginning and can connect with each impacted department in the organization at the right time and can communicate with suppliers quickly and consistently. This can only be done with a modern platform and illustrates why platforms are truly needed for Procurement agility.

True Savings Can Only Be Identified through Multi-Factor Optimization

A recent guest post from a vendor-employed guest contributor over on Spend Matters said to “Calculate Your True Savings Using Predictive Analytics”. While the doctor agrees predictive analytics can often give you a good data point as to projected savings, the reality is that it’s not always as accurate as you would like to believe and typically does not capture your best savings opportunities.

Why? Before we discuss the guest post, which did have some good points, we have to note that most predictive analytics algorithms work on trending and statistics on historical or market data, and while this can be highly accurate (95%+) the majority of the time (95%+), because market data is only historical and typically does not include data points on new (not yet introduced or announced innovations), detailed cost breakdowns on consumer / market prices, or operational insights into hidden inefficiencies whose correction can do more than shaving a few points off the top.

Going back to the post, the author states that if you use a Savings Regression Analysis (SRA) model based on multivariate regression of past-realized savings for a given subcategory to compute the savings potential under current market conditions, the target computed will be realistic, achievable, and likely mirror what you will do (despite the savings targets you set).

And this statistically based model will work if it is the same buyer (group) employing the same strategy on the same market base under similar conditions, but what could happen if a new buyer comes in that totally redefines the demand and the market strategy, or the market conditions have suddenly changed from supply shortage to supply surplus, or new production technologies could revolutionize production and trim overhead 20%? In this situation, this type of model will be significantly off.

Now, anything you can do to better predict savings is a positive, because, as the author points out, this allows for

  • better cash flow management (as you will better know your costs)
  • time to market optimization (as you will know the best time to source if you have leeway)
  • goal setting (as you won’t be trying to achieve the impossible)
  • performance management (as you can track against a realistic goal)

But while predictive analytics give a good data point, the best data point is when you use your market intelligence to build good should cost models, use optimization to minimize transportation and incidental storage and sales (and even taxation) costs (when sourcing globally), and use six sigma analysis to see if there is any opportunity to take cost out of a supplier’s overhead production cost. Going into this level of detail may indicate that while the product cost is likely to increase 1% this year (and explains why the predictive software says only 2% savings should be expected after heavy negotiations), an extensive analysis could show that a transportation network redesign could shave 3% and lean process improvements at your supplier could shave 2%, meaning that a cost reduction of up to 7% could be achieved with the right footwork (which is something the predictive model will never tell you). So use the predictive algorithms to establish a baseline, but never, ever stop there.