Monthly Archives: August 2010

Undervalued Currencies, Part I

Editor’s Note: Today’s post is from Dick Locke, Sourcing Innovation’s resident expert on International Sourcing and Procurement. (His previous guest posts are still archived.)

The value of the Chinese currency, the renminbi is getting a lot of attention. The renminbi is commonly called the yuan, and I’ll use that term here. Economists, lobbyists, legislators and others are all saying the yuan is undervalued. I agree with them.

But undervalued compared to what? Often the answer is “compared to what it should be”. That’s really vague and circular. There is one common point of comparison, though. That’s the “Purchasing Power Parity” (PPP) exchange rate. It’s not perfect reference point though. In this two-part post I’ll be covering:

  • Background of the PPP rate
  • How to determine the PPP rate for different countries
  • How to calculate over- and under- valuation
  • Countries with big differences between the PPP rate and the actual rate

Background PPP rates

The concept of the PPP rate came largely from the World Bank. They were trying to give a realistic picture of the relative standard of living between different countries by looking at per capita Gross Domestic Product (GDP). Each country measures GDP in its own currency, and that figure has to be converted to a common currency to compare countries. The common currency the World Bank uses is the U.S. dollar. They found that converting GDPs at the real exchange rate gave an unrealistically low view of the standard of living in developing and poor countries. For example, in 2009 the annual per capita GDP in China using real exchange rates was only about $3,300 per person. But a person can live much better in China on that level of income than they would in the U.S., so the World Bank developed a PPP exchange rate that shows the per capita income to be $6,600, using a PPP rate to convert from yuan to dollars.

So how is a PPP rate determined? It’s based on a market basket of consumer-oriented goods and services. It’s the exchange rate at which that basket would cost the same in both countries. What exactly is in that market basket? I haven’t been able to find that information. I do know that it’s heavy on food, clothing, housing and education costs. It may not have much relevance to industrial purchasers.

Here are two quick examples of one-item market baskets. I live in Mexico most of the time. I can see a first-run movie in a modern theater that’s equivalent to the best in the U.S. for 45 pesos. In the U.S., it would cost $10. The PPP rate for movies in Mexico is therefore 4.5 pesos per dollar (45/10). That’s the exchange rate at which costs would be identical. However, if I were to buy a laptop computer in Mexico, an $800 laptop in the U.S. would probably cost 13,000 pesos. That implies a PPP rate for computers of 16.25. (The real exchange rate is about 12.5 pesos per dollar)

More well-known, the Economist magazine periodically publishes a one-item “Big Mac” Index of PPPs by comparing the prices of Big Macs around the world. You can see some recent results by following the link.

In the next post, we’ll cover the determination of PPP rates, the calculations necessary to determine value against the US dollar, and list some countries with large differences between the PPP rate and the actual rate.

Thanks, Dick!

Share This on Linked In

A Hitchhiker’s Guide to e-Procurement: Analysis, Part I

Mostly Harmless, Part XVII

Previous Post

Analysis is often defined as the process of inspecting, cleaning, transforming, and modelling data with the goal of highlighting useful information, suggesting conclusions, and supporting decision making. However, this misses the point — analysis is all about looking into data to get insight. Nothing more, nothing less. Everything else is a pre-cursor, post-decision, or just not relevant. It’s the Analysis, Stupid.

In e-Procurement, it’s all about what did the organization do, what did the organization not do, and what should the organization have done. Of course, this is a much harder question than it may seem to be on the surface. At a basic level, did the organizational buyers follow the processes? Were the purchases on contract? Did AP pay the correct amounts? Were taxes computed properly? Were owed moneys reclaimed?

However, these questions are just the starting point, not the end report. For on-contract purchases, were prices consistent? This is very important in office electronics purchases where rates are a percentage off of “best-price”. Considering electronics tend to depreciate about 2% to 3% month-over-month, over a year, prices should decrease. However, when many organizations plot pricing for a standardized computer purchase over the course of a year, they will find that prices stay relatively flat. For off-contract purchases, were prices reasonable compared to market index? How much did maverick spend cost the organization? Was any of the maverick spend justified? Did AP pay the approved (adjusted) amounts?

But the questions shouldn’t stop there. Were the spending patterns consistent? If spend on a particular category abruptly rises in a department where it was consistent year-over-year for the last three years, something is amiss. If claims for a particular employee are the same month over month when they usually follow a sinusoidal curve, something is wrong. If off-contract spend increases rapidly, something is very wrong.

Thus, directly or indirectly, a good e-Procurement system will support in-depth analysis of the process, spend, and results. This means that if the platform does not contain a true data analysis tool, it should support full export of all relevant data in a standard format that can be imported by such a tool for analysis. This is because, when all is said and done, the biggest savings will come from improving the procurement process itself. This requires insight, or lessons will never be learned.

Next Post: Analysis, Part I

Share This on Linked In

Oh-Oh!

Editor’s Note: Today’s post is from Dick Locke, Sourcing Innovation’s resident expert on International Sourcing and Procurement. (His previous guest posts are still archived.)

Indranil Mukherjee / AFP-Getty Images from MSNBC Photoblog

Best reader comment: “Sh@#$% ! My Porsche was in that container, I suppose I’m not going to get it by Friday “

Full story on MSNBC.

Fortunately for the environment and the supply chain, this doesn’t happen often.

Thanks, Dick!

You Did Not Predict the Weather? Too Bad. See You In Court!

As if you didn’t have enough risks to worry about, now, as per this recent article in Industry Week on “Climate Change Risk Management”, you now have a new risk to worry about. If you don’t anticipate extreme weather events that can cause sudden and material damage to business assets, interrupt business operations directly, or disrupt key elements in transportation or support activities, then you might be sued by your investors for losses from your failure to disclose and anticipate those risks, just like American Electric Power Company was sued by the state of Connecticut.

Right now most of these claims are limited to “public nuisance” claims based on GHG emissions (which, according to various plaintiffs, have contributed to events like Hurricane Katrina), but they could be brought under security laws in the near future, now that the SEC has issued interpretative guidance for publicly traded companies related to climate change disclosure. Any company that fails to disclose in accordance with the guidance could be on shaky ground, especially now that shareholders’ resolutions for disclosure of management’s responses to climate change are becoming much more frequent in proxy statements.

In other words, if you’re not identifying all your risks, disclosing all your significant risks, and preparing to mitigate those risks, you’re not only on the fast track to major disruption and loss, but lawsuits that drag on forever.

Share This on Linked In

Is Your Supply Chain Organization Ready for the Decade Ahead?

A recent article in the Harvard Business Review outlined “seven questions to ask” to find out if you are ready for a rebound. What I found enticing about the article is that these seven questions have supply chain corollaries. If you can’t answer yes to these seven questions, chances are that your supply chain will not be ready for the decade ahead.

  1. Do You Take Advantage of Opportunities Others Miss?Many companies continue to miss market and technology shifts that their rivals exploit. If you’re in this camp, you’re going to fall behind your competitors as they adopt better practices, better technologies, better suppliers, and better transportation options. For example, this means that you should have adopted real spend analysis and strategic sourcing decision optimization by now, as these are the only two sourcing technologies proven to repeatedly deliver double digit savings time and time again (at an average of 11% for spend analysis and 12% for decision optimization).
  2. Are Your Hydraulics Oiled and Flowing Smoothly?As per the HBR article, organizational hydraulics are the mechanisms that senior executives use to translate corporate objectives into aligned action by individuals across the organization. If there are too many initiatives, priorities, or conflicting goals, then the hydraulics get overburdened and break down. Limit your goals to 2 or 3 and initiatives to the top 4 or 5 opportunities and excel in the execution of those initiatives most likely to deliver the desired results. For example, if your sourcing team is limited, do a spend analysis and identify the top 5 categories with the greatest savings opportunities and those are your priorities for the quarter. Everything else can wait. It’s better to save 10% off of 100M than 20% off of 10M.
  3. Does Your Organization Reward Excellence?Or does it reward mediocrity and call it teamwork? Organizations should not only reward individuals who do what they say the will and meet, or exceed, their (stretch) goals with outsized bonuses, but remove compensation caps. If your top sales person or top buyer ends up taking home more than the CEO, that’s a good thing! It generally means that he sold (tens of) millions worth of product or services or she saved (tens of) millions of dollars for the organization. And if you’ve hired a smart CEO, and given her a piece of the company, she’ll be grinning from ear to ear as the value of her stock soars as a good CEO is in it for the long term.
  4. Are Your Core Values Aligned to Success?Or are they a joke? If your organization looks up to a bullcrap mission statement like “we synergize our processes to bring value to our customers”, then your values are probably a joke. But, on the other hand, if you focus on achievement, ownership, teamwork, creativity, and integrity … then you’ve got the framework for building a truly world class supply chain organization.
  5. Are You Talking About the Right Things?Or focussing on irrelevant minutia because you don’t have the guts to take on the elephant in the room that is the real impediment to your progress. If you spend your days looking for the next fire to put out instead of addressing how you’re going to weather the market storm that’s brewing, you’re talking about the wrong things and will be battered badly when the storm hits. Optimality in the supply chain is fleeting — even if you’re lucky enough to obtain it, it will quickly fade. The organization must always be on the lookout for the next process or technology that will increase efficiency and stability.
  6. Are Your Warriors Still Fighting?Or have your Vikings become farmers? If your team spends their time tweaking the last initiative until they’ve eeked out every last fraction of a percent of the perceived savings opportunity instead of diving into new opportunities as soon as they’ve extracted 80% of the potential value of the current opportunity, then your team has transitioned into a community of farmers content to live a peaceful and stable life. From an organizational viewpoint, this is bad since fields can be wiped out by a single flood and the only way to sustain success is to keep going after the next big opportunity. Furthermore, since it will generally take four times as much work to eek out the last 10% to 20% of savings, it’s just not a good investment of your team’s time. Follow the 80/20 rule if you want to maintain success.
  7. Are Your People Self-Sufficient?Or does everything come to a stand still every time you spend a few extra minutes in the lavatory? As the article says, senior executives who dash from crisis to crisis are a sign of organizational weakness, not leadership strength. If your team is truly strong, they will be able to function without your leadership and solve crisis on their own. You should be able to disappear for a month without any adverse effects to the organization. A good leader focusses on building the team, providing them with the support they need, and preparing them for future advancement — she doesn’t solve their problems for them. She gives them the training and support they need to solve their own problems

Share This on Linked In