Category Archives: Economics

There’s NO Faster Path to a Markdown than “Growth At All Costs”!

THE PROPHET is bemoaning the start of markdowns in private equity when he should be happy (as a former investor) they took this long to happen, especially when the reality is that these markdowns are going to start coming fast and furious in any firm that wants to still be around by the end of the decade.

This is because most of their portfolios in Software, and FinTech/ProcureTech software in particular, have been pursuing growth at all costs as a result of:

  • the insane valuations during COVID for FinTech/ProcureTech that helped companies buy and pay online
  • the insane valuations during the current AI-HYPE for any company that could convince the investors they had a unique AI capability (even if it was just a clod or chat, j’ai pété wrapper)

… which has resulted in unreasonable, and practically unachievable, sales and growth targets being placed on them which they will not reach, especially in a flat, or down, market for software purchases as a result of the AI price squeeze (since “AI” offerings are currently cheap with the big firms underpricing compute costs to try and hook clients, even though it’s costing those firms Billions).

But as Garry Mansell, one of the Godfathers of Modern Procurement, has so eloquently explained in his can of worms post, growth at all costs is equivalent to self-sabotage. That’s because it comes laden with fallacies, traps, and brand value destruction!

Garry points out the three biggest harms we see every single time.

  1. Quarterly Earnings Trap: with the constant pressure to reach unreasonable, if not unobtainable, sales targets, it becomes all about delivering good news on the quarterly earnings call (whether to the public or the PE firm); it all boils down to revenue and cash in the bank, and sales teams are told to hit targets by any means necessary, including, but not limited to, deal-making, over-promising, and grand assurances the solution will solve that problem without any plan to ensure it will do just that once the deal is signed; this leads to unhappy customers when the implementation will take a year (vs. the three months they expected), the expected enhancement needed to solve that problem is pushed two years down the roadmap, and the customer support is non-existent (because all the support reps were fired to fund increases in the S&M budget to try and hit the insane targets)
  2. Heavy Discounting Fallacy: because it will get “not ready” or “likely to go with a competitor” customers over the line and get the deal in the door; first of all, it doesn’t always happen (as some customers see through it and then spot the “we have the right to reprice on a quarterly basis if your user base goes up, and we get to use LinkedIn growth metrics to do so” clause where, even if you hired a dozen janitors for your new office building or 50 fleet drivers for your new private fleet who never use the system, you will be charged for them anyway); secondly, even if it does, given that the smart ones know the old adage “you get what you pay for” is true, if they didn’t pay much, they will believe it’s not worth much and not put in the hard work that’s required on their end for a successful implementation (especially since they also know you can’t afford to, and thus won’t, support them at that price); third, voices carry, word gets out you’re cutting quotes 80% to 90%, and suddenly everyone knows (or at least assumes) you’re doing massive mark-ups with the sole intent of getting whatever you can (and not what the tech, and the IP contained within, is really worth — as you’ve just devalued the IP to the floor)
  3. Shelfware is the Reputation Killer that Keeps On Killing: Good software that generates value for a valued client that uses it daily is the gift that keeps on giving because a happy client, as long as you keep your prices fair, never goes away; but shelfware is the villain that keeps on striking at your darkest hour as that unhappy client will never tire telling people how you are robbing them blind in a contract they can’t get out of for software they aren’t using …

As Garry has said repeatedly, which SI has echoed repeatedly (while giving you a simple relative corporate debt equation to help you calculate how likely that vendor is pursuing growth at all costs, and, thus, likely to screw you [whether they intend to or not]), the only true growth is controlled growth with ready-clients at a sustainable year-over-year rate that allows all customers to be served to expected levels of service, all new employees to be adequately trained before being thrust into critical customer-facing roles, and all current employees to get the regular time off they need to prevent burn-out.

And, as Garry has also pointed out, where the model incentivizes utilization and renewal over implementation and sale, where every member of the organization is incentivized on those metrics, where the sales person doesn’t get a dime of commission until go-live and where the full commission depends on adoption and renewal, that’s where you will see success. (In other words, the sales person should NOT be happy if the client isn’t. That’s one of the best ways to de-incentivize bad deals — what salesperson is going to bend over backwards and/or pull every dirty trick in the book to get a deal he’ll never see a dime of commission on?)

When you remember Kraljic, don’t forget Coase!

Coase laid the original foundations … Kraljic gave us fundamentals … and now the Busch-Lamoureux Exact Purchasing Framework is building on that to give you a guide to modern Procurement!

The Kraljic matrix is broken. A big problem, as we have regularly explained, is that you can’t compress two independent dimensions (risk and complexity) into one. A little problem is people don’t understand how to qualify the importance of a purchase. It has nothing to do with cost or volume but everything to do with the organizational impact if the product or service being purchased suddenly becomes unavailable. Similarly, it has nothing to do with how much you buy from the supplier, but how critical it is they don’t go out of business. It might be a critical component, but if there are ten other suppliers who can meet that demand for you tomorrow, the supplier is not critical to your organization.

But the biggest problem is that people regularly misunderstand the purpose of the matrix — it was a tool, and the first of it’s kind, designed to get us thinking critically about purchasing and point us in the right direction. It wasn’t the be-all and end-all. It was the first formal methodology an organization had to segment purchases and suppliers, think about them critically, and approach sourcing and supply assurance methodologically. And it was created in a time when global sourcing was more predictable (because natural disasters were a fifth of what they are today, war’s didn’t breakout overnight without warning on the whims of a mad man stuck in a macho cold war colonial mindset), risk was primarily complexity, and if you used the methodology, you probably had a success rate of 90%, which was phenomenal.

Kraljic gave us a way to structure our critical thinking and improve the profession, and all most consultants did was water it down, create a one-size-fits-none methodology, and sell it like it was the next panacea, creating a consulting snake oil from a masterpiece of thought.

A masterpiece of thought you only understand if you understand the framework in which it was built, and those were foundations laid four and a half decades earlier by Ronald Coase in his 1937 essay “The Nature of the Firm“.

The framework was that of organizing the supply management operations of a firm, where the definition of the firm was the one put forward by Coase, which is essentially that the firm was the mechanism by which transaction costs were minimized. (Otherwise, there would be no need for a firm!)

Transaction costs are the result of the price mechanism of the open market, and include:

  • the cost of the negotiation and contract
  • the cost of the individual transactions the contract covers
  • the costs associated with production

and include all of the factors (people, equipment, technology, etc.) included in these prices.

This tells us that the fundamental purpose of a firm is … PURCHASING! And the only way a firm can grow is if it can continue to PURCHASE cost effectively (because as soon as the cost of subsequent transactions and / or production exceed the market costs, the firm is dead).

However, as most firms grew, they reached a point of inefficiency (due to management overhead, process inefficiency, and/or paperwork and/or communication point overload), and growth stopped. Also, as they grew, they became more brittle and sensitive to even tiny disruptions.

Kraljic recognized this and introduced the matrix so that firms could approach their purchasing in a more structured manner that would reduce the brittleness, simplify the management, and allow for additional growth and resiliency. And it was a great start.

But simply classifying items into non-critical, leverage, bottleneck, and strategic misses they key point of the firm’s existence. And that’s to ensure that the costs related to the category are not only always lower than the market cost, but remain low as the company scales.

When you classify an item as non-critical, it becomes ignored tail spend, and we’ve seen time and time again that the average overspend in this category is at least 15% in most companies, with many products and services being bought 30% more over market price.

When you classify an item as bottleneck, you focus on assurance of supply, and don’t dive into determining whether an item is a bottleneck because it can only be supplied by a rather limited supply base or because absence would shut down a production line. (Just because only a few suppliers produce the item to your specs doesn’t mean that only a few can, there might be a few dozen that could, and would, produce it to your specs [at a higher quality at the same price] for a guaranteed mid-to-long contractual commitment.)

When you classify an item as leverage, you double down on price (and exploitation of the price mechanism), and this can often come at the expense of quality and dependability, which can result in higher costs later if warranties come into effect or you have to replace products faster than normal (which always incurs a replacement cost in manpower and opportunity that is never factored into the “we can afford 4 of these per decade vs 3” equation).

When you classify an item as strategic, you triple (or more) the amount of effort you put into the management of that item (or category), and there is a point where the excess time investment not only fails to keep to the associated contract and transaction costs below market, but leads to no additional return on cost investment.

This is because the profiles don’t take into account the separate dimensions of risk and complexity or ensure that “importance” is defined as true “impact”, or provide any mechanisms for determining the impact (or risk or complexity).

This is why you need to go back to the foundations and build up a framework that is capable of capturing what the firm really needs!

That’s what the Busch-Lamoureux framework is intending to do.

By organizing categories based on complexity, risk, and impact

  • the cost of the negotiation and contract is based on the complexity, risk, and impact — where all are low, the whole process can be automated and costs minimized
  • the cost of the individual transactions the contract covers are minimized to verification of only what is important, and humans are only involved when automation can’t do that or finds a discrepancy
  • the costs associated with production are minimized as you are selecting a supplier that meets all of the necessary requirements at the minimum cost subject to an acceptable risk factor!

Furthermore, you’re making your contracts for durations appropriate to the category such that you’re adequately accounting for complexity and risk without locking yourself into long term deals that are not beneficial to your organization!

But most important, because the categorization helps you determine how much manpower you actually need to spend on each sourcing event, contract, and transaction, your organization is much less likely to experience decreasing returns as it grows, allowing it the funds it needs to ensure Procurement is appropriately staffed and resourced with the right systems.

Coase gave us the definition of a firm (PURCHASING)! Kraljic helped us understand the fundamentals we need to consider in our modern world. Now we’re giving you a framework to apply those fundamentals in a manner that will let you scale without fear of unnecessary waste. Go forth and transact! (The market depends on it!)

Another Reason To Avoid AI: NO ECONOMIC GROWTH COMES FROM AI!

A recent study by Goldman Sachs, summarized in Fortune, found no meaningful relationship between AI and productivity at the economy wide level/.

Think carefully about that. 450 Billion, which is more than the GDP of over 100 countries, was sunk (and I mean sunk) into AI last year — for the net result of ZERO economic growth. For 1/6 of that, every college in the US could be free — and you’d have 20 Million smarter adults with no student debt dragging them down, causing them stress, and zapping from their productivity. For 1/12 of that, you could eliminate all the hunger and food insufficiency in the US. For 1/50 of that, you could re-open Alcatraz and provide a King with his own special castle and his own moat.

In other words, there are so many better things that could have been done with that money — including training your people to be more productive, modernizing processes for efficiency, and building deterministic tech that actually works at 1/100 to 1/10000 of the compute power in a data center that’s already powered up.

The only company “winning” is Nvidia, who provides the chips, which means that most of the money is going to its factories in Taiwan and South Korea, and those are the only countries that are actually winning while Americans, who were laid off in droves last year, get poorer, colder and hotter, hungrier and thirstier (as AI sucks up all the energy, which is now not available for heating or air conditioning, and all the water for cooling, which is now not available for drinking or farming).

Think about that the next time you think an overpriced clod or chat, j’ai pété wrapper, even if hyped up as an AI Employee by the A.S.S.H.O.L.E., is going to solve all your problems. Especially since all the Age of AI has done for us is make us dumber, poorer, and less prepared for what is to come next than any age that has come before.

Primary ProcureTech Concern: Weakness & Volatility in Emerging Markets / Trade Wars

Emerging markets are your future markets, and often the source of critical raw materials.

Why?

Given that a lot of outsourcing has been redirected to these “low cost” markets over the past two to three decades, any rapid increase in volatility becomes a significant concern, especially if the markets are not strong enough to weather the storm. A major event could wipe out an entire subset of the supply base literally overnight, greatly increasing supply shortages and increasing the market complexity. Or at least make it unsustainable, such as a 145% tariff on China which is the source of over $500 Billion dollars in imports into the USA.

Impact Potential

The impact of a “low cost” market becoming unavailable, or at least unsustainable, is moderate to severe, especially if all of your outsourced eggs are in the same country basket. One lesson that some companies haven’t learned yet is that dual sourcing is not reducing risk if the two sources of supply are in the same country (or the same small geographic region — because if you have two factories located 100 miles from each other on two sides of a border, guess what, one natural disaster can wipe them both out).

If your primary source of affordable supply is wiped out overnight, it could take months to identify a new source of supply and quarters to secure the supply and get your supply chain flowing properly.

Major Challenges/Risks

Foreign Market Predictions
It’s hard to predict what’s going to happen in a foreign market that you aren’t in everyday. You can follow economist predictions, follow currency trends, try to get a grip on the trade relations between that country and your home country, and so on, but it’s not easy. If you can predict early enough, you can take action. But if an administration, without warning, decides to drop 100%+ tariffs on your source of supply, you’re in trouble.

Alternate Sources of Supply
Sometimes there’s few sources of supply for a given material, part, or product outside of a given country that has a similar total cost of acquisition, especially if you aren’t sourcing at full volume. Identifying alternate sources of supply that you can switch to quickly can be quite a challenge.

New Market Identification
If the emerging market also happens to be one of your primary emerging sales markets, the hit from volatility can be quite significant if the volatility results in rapid inflation, job loss, or both and your sales start to drop rapidly.

Final Words

Given the globalization of today’s supply chains, where a product can depend on materials and parts from dozens of countries, weakness and volatility in emerging markets is a significant concern. And we have yet another (fourth) reason you need an economist!

Primary ProcureTech Concern: Tightening Credit Conditions

The world runs on money, regardless of what form it comes in. Gold, cash, or credit. Credit is particularly important because it helps an organization bridge between cash cycles.

Why?

If economic downturns or inflationary pressures arise quickly, then credit will also tighten.

Impact Potential

If the organization, or its suppliers, needs credit to produce and distribute the goods for sale, the lack of interim credit could lead to reduced inventories and sales and even bankruptcies.

Major Challenges/Risks

Economic Market Prediction:
Predicting whether the economy is going to grow, stay flat, or recess (or depress) is the first challenge, as that’s a leading indicator of credit markets.

Credit Market Prediction:
Based on the projected economic changes, predicting the base and prime rate changes, availability of credit, and the future cost to your organization and your primary suppliers.

Alternative Credit Sources:
If your primary sources are projected to become considerably more expensive or restrict credit access, can you identify alternate sources? Moreover, how much will those cost, how long to establish the relationships, and how reliable will they be?

Alternative Credit Arrangements:
If right now you are just using loans or lines of credit, maybe you need to consider early payment discounts, invoice factoring, or alternative supply chain based credit arrangements.

Final Words

Credit conditions depend heavily on economic conditions, so this is yet another reason you need a good economist.