Category Archives: Cost Reduction

Don’t Fall for the FUD!

Now that money is trickling back into technology budgets, many vendors are going on the offensive again. As a result, you need to be ready for the emergence of the vendor FUD (Fear, Uncertainty, Doubt) machine that is sure to resurface. We’ve already tackled how you calculate the true TCO/TVM of each product under consideration, thereby helping you to dispel the first piece of FUD you’re sure to hear, which will be along the lines of “we’re the cheapest and have the highest ROI, while our competitor is the most expensive and your ROI will be negative if you go with them“, but once you get past this, any vendor with a decently aggressive sales force will have more FUD loaded up and ready to fire (if they feel they are at a disadvantage). Here are three common pieces of FUD that, to be blunt, don’t mean nothing.

  • Our competitor is being sued (by us).So? Many of the lawsuits in this space are nothing more than desperate attempts by the bigger vendors, who haven’t innovated in years, to literally sue their smaller competitors out of commission with baseless lawsuits that plaintiff hopes will be too costly for the defendant to defend (as the plaintiff will attempt to draw the discovery phase out for years before the case gets inevitably thrown out).
  • Our competitor can’t do Fliggle-Flaggle-Floogle.Many vendors with less competitive or innovative offerings will focus on one or two impressive sounding (but essentially worthless) features that their competitors don’t have and turn up the tech talk dial to eleven in hopes of confusing you into buying their product. Don’t fall for the tech talk. It’s not about the technology, but about the value it can deliver to your organization. And sometimes its best not to buy the technology at all, but to contract with a consultancy or BPO who can maximize its potential (especially if the value curve flattens out quickly, as it does with tactical spend analysis [reference]).
  • You have to go all-in.Many providers will insist that you have to buy the whole suite, complete with licenses for every user in the organization, or you won’t realize the full value available to you. So what? It’s not about how many pennies you can squeeze out of the technology, but about how many pennies you can push down to the bottom line. Let’s say you can buy a solution for Procurement only from a competitor for 50K and that you expect you would drive 500K in savings from the purchase. Now let’s say you can buy their solution for the whole organization for 250K and drive 1.250M in savings. Which is better? The Procurement solution. It has a 10X ROI, compared to the 5X ROI the full organizational solution offers. Furthermore, when you look carefully, you see that the extra 200K only saves you an additional 750K, which is an ROI of only 3.75X. Yes, you want to save that additional 750K, but if you keep looking, you might find another 50K point solution from another vendor that will save you 500K of that 750K, which gives you another 10X ROI (and makes the organizational solution a bad buy since you’d now be spending another 150K to save 250K, which gives you an additional ROI of only 1.67X …. which means that one stumble on the organizational solution path and you would have been better off with the (much) less expensive and (much) lower risk point solutions).

And don’t forget, if the management/ownership team hasn’t changed much, what Tweety Bird has been saying for years still holds true. Don’t get fooled. Once a bad old putty cat, always a bad old putty cat.

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Know Your Software TCO & TVM

I’m a big fan of SaaS (Software-as-a-Service). I’m a big fan of the many benefits it offers, including almost instant deployment, immediate upgrades, and the fact that the provider handles the administration, maintenance, security, upgrades, backups, and other IT headaches that most companies just don’t have the IT resources for. And I’m a big fan of the economies of scale that are inherent in a true multi-tenant instance. But I am not a big fan of the recent marketing by a number of the vendors in the space that have recently gone “on-demand”. Most of these new “On-Demand/SaaS” providers have taken a myopic focus on TCO in their marketing, and are making strong claims that On-Demand/SaaS is always cheaper – which is not true.

Regardless of the software delivery model you select (on-site, hosted/ASP, on-demand/SaaS), there are a lot of factors to consider with respect to the Total Cost of Ownership and which model is cheaper ultimately depends on the specifics of the vendor pricing and your internal costs of support. A true multi-tenant SaaS provider who takes full advantage of the economies of scale across a large customer base and who passes those savings on to you will often be cheaper, but this is not always the case. Some On-Demand/SaaS providers aren’t as cost efficient as they claim, some solutions require a lot of manual (data) maintenance and user support (which results in hefty service fees), and, let’s face it, some providers, who will do a magnificent job of convincing you that on-site costs more than it actually does, will charge as much as they can get and use the bulk of your monthly subscription fees to line their pocket books with large annual bonuses. If you can’t calculate the true TCO of each solution under considering, you’ll never know which solution is more cost effective and when you’re truly getting a good deal.

I’ve addressed this issue in the past for e-Sourcing and e-Procurement systems in my post on uncovering the true cost of on-premise sourcing & procurement software (spreadsheet), but since many of you will soon be buying / upgrading again now that money has finally started to trickle back into your budgets, I thought I’d address it again. Especially since the calculation isn’t that much more involved for just about any type of Supply Management technology you might be considering. Basically, all you do is compute the (expected) x-2, x-1, x, x+2, and x+2 year amortized solution cost for the length of time, x, that you expect to maintain and use the software (based on typical enterprise solution lifespans in your organization) for each product under consideration, compute the average annual amortized cost, compute the expected savings, and select the solution with the highest ROI that best fits your organization.

Depending on the delivery model, the following will contribute to the total solution cost:

  • License Cost
  • Maintenance Costs
  • (Expected) Upgrade Costs (to Major Versions)
  • Base Hardware & Networking Costs
  • Hardware Upgrade Costs
  • (3rd Party) Data Costs
  • Database / Data Warehouse Costs
  • Application Server Costs
  • Reporting / Analysis / Optimization Engine Costs
  • Other Required Software Costs
  • System Design, Implementation & Integration Costs
  • Security Costs
  • Support Costs
  • (Re-)Training Costs

You calculate the total cost for each time-frame on a cost component basis using expected upgrade schedules, pricing trends, and expected utilization curves. Then you divide the expected total cost of ownership by the time frame and you get your annual amortized cost, or TCO by year.

Then you compute the expected savings by computing the expected cost savings in each of the following primary dimensions:

  • spend reductions (you expect to realizeequal to savings you expect to negotiate minus savings you expect to lose to maverick spend)
  • efficiency / productivity improvements
  • risk mitigations (which prevent losses due to supply disruptions, non-compliance fines, etc.)

Finally, you can compute the (annual amortized) ROI, or the Total Value Management, of each solution as the (annual amortized) expected savings / expect cost. Then you can truly compare each solution under consideration on a cost, and value, basis.

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Global Sourcing: Addressing Myths with Capabilities Part I: Cost & Quality

Today’s post is from David Henshall, Founder of Purchasing Practice. Dave can be reached at dhenshall <at> purchasingpractice <dot> com.

In this four part series, we examine eight dimensional capabilities that will help you overcome the myths surrounding global sourcing. In today’s post, we will focus on the two dimensions of cost and quality.

The myths surrounding global sourcing are many, widespread and often misleading. They usually revolve around business conducted in developing countries, the so called low cost country sourcing (LCCS) countries. LCCS is fertile ground for the politicians, humanitarians and environmentalist alike, covering misleading sound bites ranging from the export of jobs to the exploitation of child labour and the carbon footprint of the 3000 mile salad.

With the prospect of such reputation damaging headlines, it is critical for firms engaging in global sourcing to get their strategy right. This strategy must be supported by sound operational capabilities that not only manage the supply chain and the relationships within it, but that also make use of a well thought out communications strategy (should unwanted publicity arise).

Purchasing Practice has developed a global sourcing framework (GSF) that incorporates these concerns into a logical management structure, and categorises them under eight dimensions.

 

The Eight Dimensions of the GSF

  1. Cost
  2. Quality
  3. Corporate Social Responsibility
  4. Risk
  5. Opportunities
  6. Politics
  7. Local Context
  8. Enabling Infrastructure
Global Sourcing Framework
Click to Enlarge
The Breakdown of Global Savings Costs
Traditional Model

(based on industrial products example)
labor savings 20-25%
depreciation 5-10%
materials and components 10-15%
economic development incentives 0-5%
savings on manufacturing cost (subtotal) 50%
logistics, inventory costs -10-15%
ongoing management costs -5-10%
taxes and duties -0-5%
net cost savings 25%
Procurement Strategy Council Model

(factoring in hidden costs not considered in the traditional model)
cost savings in traditional model 25%
business partner non-participation -8%
business partner non-compliance -6%
savings (subtotal) 11%
resource intensive sourcing activities -4-5%
reputation risk exposure and mitigation -1-2%
actual savings realized 4-6%

 

Dimension #1: Cost

Whilst costs are typically a primary driver of global sourcing, organisations must not only factor in total landed cost but also issues such as infrastructure cost and increased risk. This can include the cost of setting up a local office or hiring external auditors to monitor your suppliers in a particular country. Additionally, an upfront investment is frequently necessary in order to ensure the sourcing relationship is aligned with business goals and policy.

When these factors are quantified in a sourcing decision, the incremental savings from sourcing to a higher risk region or country are sometimes eliminated, especially when the principle benefit is labour arbitrage. However, many organisations are finding that the benefits of global sourcing still outweigh the investments if the right global partner is in place.

According to a Procurement Strategy Council report:

“Traditional models assessing the costs of global sourcing most often consider higher logistics and inventory costs due to longer supply chains, greater management costs to oversee remote and (often) unfamiliar supplier relationships, and higher taxes and duties. While these costs can reduce net savings by roughly half, emerging markets still provide a significant cost advantage of upwards of 25% savings.” See the breakdown of global savings cost table (above).

So whilst there are low cost countries, global sourcing will always be worthy of a buyer’s attention. Buyers should, however, be aware that the state of comparative cost advantage is dynamic, not static. This is true both within and between competing countries. Buyers must therefore possess the skills and motivations to monitor these dynamics as part of their overall sourcing strategy.

Dimension #2: Quality

Quality is usually a given in procurement organisations these days and is not ‘knowingly’ compromised for cost savings. Successful LCCS can deliver quality that is equal to, if not better than, local sources. This is in part achieved by working with suppliers to help them reach the desired quality standard prior to calling off production. When this is the case, it must be recognised as an additional cost of doing business and factored into sourcing decisions over the long term. The key lies in putting in place all the right quality processes and checkpoints throughout the supply chain by qualifying inputs before they become embedded in products.

The increased risk of materials substitutions (i.e. lead paint and low grade materials) can also be driven by the refusal of Western buyers to allow suppliers to pass along cost increases which become amplified during a recession. So buyers must consider this when reviewing prices with suppliers.

Part 2 will examine Corporate Social Responsibility in global sourcing.

Thanks, Dave.

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Supply Chains are More than the Sum of Their Parts

Everyone should read this recent article in Strategy + Business on Virtuous Connections that presents a case study on how local “fixes” that don’t take into account dependencies can actually result in global “breakdowns”. The article, which presented a case study from a large chemical manufacturer, described how numerous attempts to “fix” existing supply chain issues resulted in the creation of additional supply chain issues that were even worse and more costly.

For example, the article describes how:

  • they focussed on pallet standardization, only to find no performance improvement because being able to load a pallet faster doesn’t help much if the products aren’t ready when you need them;
  • they installed a system-wide network that couldn’t handle the volume of incoming orders because management underestimated the range and volume of the company’s channels; and
  • they tried outsourcing warehousing, which made matters worse because their software didn’t integrate with the 3rd party’s software.

But when a more holistic view was taken and Supply Chain focussed on:

  • segmenting customers by strategic importance, which allowed reps to give customers a more realistic picture;
  • eliminating rogue stock-replenishment processes by replacing them with new, standardized processes dictated by a properly selected and calibrated inventory system; and
  • including risk constraints in schedule production that took into account order complexity, which greatly increased schedule predictability,

the results were astonishing. Inventory on hand decreased by 20 percent, shipment costs stabilized in a period of rising fuel prices, and stock-outs fell by 50 percent — resulting in exponential gains.

When they failed to look at the big picture, intended “improvements”, including the selection and integration of expensive new systems, had disastrous consequences because their “side effects” were never taken into account. But when they analyzed the system as a whole, even minor changes had major positive impacts. You need to look at your supply chain as a whole, and select systems that allow you to analyze the supply chain as a whole. Otherwise, that “fix” might introduce a fatal flaw!

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A 2-Minute Opportunity Checklist for Supply Chain Initiatives

Slightly modified, the 2-Minute Isenberg validation test for business ideas, as chronicled in this HBR Blog post on “the 2-minute opportunity checklist for entrepreneurs”, is a great test to determine which supply management initiative you should run with. Specifically, if you line up your opportunities, the one that scores highest is the one most likely to get the organizational support you need for success and the one that you should focus on in your quest for purchasing fire.

It’s 17 short questions, and I would recommend that you answer yes to at least 13 of them before proceeding with any effort that is going to take a lot of time and resources.

  1. Will your initiative ease the pain, frustration, or dissatisfaction of someone outside of Supply Management?
  2. Are there more of these people in the organization?
  3. Will any of these people commit budget or resources to get it done?
  4. Will they be able to make a decision to support your initiative quickly?
  5. Does the initiative exploit and showcase a strength of Supply Management?
  6. Are you able to bring to bear unique assets in the initiative?
  7. Can you think of at least two C-Suite executives who will support you?
  8. Can they commit resources with complementary skill sets?
  9. Will they see the value that you do?
  10. Do you have evidence that you will be able to convince a majority of the decision makers that your idea is a good one?
  11. Will at least one person disagree with you?
  12. Is the idea compelling enough that your staff will do what it takes to get it done?
  13. Can you sneak by the trolls in accounting and get it done?
  14. Can you find someone in the organization who will commit to trying it and help you work out the kinks?
  15. Can you start without a huge cash outlay up front?
  16. Can you keep the long-term costs low?
  17. Does the initiative lay the foundation for future incremental initiatives that will generate more cost reductions and additional value?

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