Category Archives: Economics

Energy Buying Is Definitely Not For Those Looking for a Quiet — or Easy — Life

A recent article over on the CPO Agenda on how “energy buying is not for those looking for a quiet life” made some great points. As the article notes:

  • there is continuing political unrest in many oil-producing nations (and 20%+ of available oil goes to international shipping alone [Source])
  • the recent Japanese disaster has cause a renewed apprehension to nuclear energy production (and Germany is going to decommission its nuclear plants that supply 25% of the country’s electricity)
  • in most countries, renewable sources still account for less than 5% of electricity production
  • demand for fossil fuels is still rising, and the rapid rise of China and India which, combined, hold over 1/3 of the planet’s population combined, isn’t helping

Plus:

  • significantly increasing energy production from renewable sources, while now a technical feasibility, will cost many (many) Trillions of dollars which have to come from somewhere (as a side note, 2010 saw a record level of investment of over 240 Billion — but we probably need at least 10 times that for a rapid increase in the production of renewable power)
  • deregulated energy markets, which will soon account for a majority of state markets in the US, allow money grubbing financial types to play hedge games (and we know what eventually happens to hedge markets when Wall Street types get involved)

And:

  • energy cost models can be complex: costs of generation, transmission, storage, distribution over third party networks, and taxation, each with their own cost models, need to be taken into account

All-in-all, you are dealing with a very complex, and very volatile, commodity whose price performance can be almost impossible to predict even in the short term. And even if you manage to lock in a mid-term contract at great rates, what happens if prices spike and your provider goes bankrupt because it predicted downward performance and signed too many deals at the start of what was actually an upward trend? Or if you decide to generate your own electricity and your fuel supplier all of a sudden stops delivering? There will be sleepless nights. Unless you thrive on them, beware of energy buying. It’s not for the faint of heart.

What China’s Five Year Plan Ultimately Means for Your Business

If you are sourcing from China because it is part of your LCCS (Low-Cost Country Sourcing) Strategy, you will need to find a new low cost country to source from. Just like India is no longer a low cost country for call centers and outsourced support, it won’t be long before China is no longer a low cost country for manufacturing. As clearly pointed out in this recent McKinsey Quarterly article on “What China’s five-year plan means for business”, the plan targets:

  • a 13% increase in minimum wages each year,
  • an annual increase in household income of 7% each year,
  • new policies for pricing energy, raw materials, and water … that will increase costs further … and
  • tighter environmental regulations … that will increase costs even further.

In other words, your labor costs will be 84% higher within five years. And your raw material and environmental disposals cost will likely see a comparative price increase. Low Cost Country? Not anymore!

The Control Provided by e-Sourcing is Only an Illusion – YOU HAVE NO CONTROL!

A recent post on one of the lesser known sourcing blogs indicated that, due to the lack of economic upturn in most of the developed world, maybe now is the time to finally try reverse auctions. The rationale, quotes from a CEO and his team that watched their first reverse auction that indicated that it was simple, powerful, easy to follow, effective, and, most importantly, if you read between the lines, gave them an illusion of control over the process and the results.

This, and some of the messaging coming from a few of the smaller e-Sourcing providers, is scaring me. I fear that adopters may believe that adopting this technology may give them some control. Well, as this recent article over on Chief Executive on why you should “embrace tomorrow’s strategies” clearly points out, you have NO control! You can manage the process, but you have no control over the outcomes. Why? For starters

  • Cartels, cabals, speculators, organized crime, and entire countries are constantly manipulating commodity prices.
    Case in point: China possesses over 90% of many of the rare earth metals used in many technologies (smart phones, batteries, etc.) and when they recently reduced exports, a steep price increase resulted that triggered a costly disruption of delivery of the precious commodities to global business.
  • Disasters are on the rise.
    Industrial, agricultural, and political disasters are increasing in frequency and wiping out production in entire regions. For example, the nuclear meltdown in Japan affected most businesses that rely on a Japanese supplier.
  • Global currency fluctuations, unforeseen credit crises, and economic stagnation are increasingly severe and unpredictably enduring.
    The extreme fluidity in the valuation of imported and exported goods, services, and components is as equally difficult to predict and manage.

No e-RFX or Auction is going to help you regain control over these economic nightmares that you have to deal with on a daily basis. And any provider that’s trying to sell you 1999 e-Sourcing technology to deal with the current economic stagnation doesn’t have a clue. There’s only one way you can even hope to adapt to the constantly changing reality, and that is through the adoption of a supply management platform with advanced data analytics capability. You have to constantly monitor, react, adapt, predict, plan for what-if, monitor, react, and adapt again. This requires extensive data acquisition, mapping, transformation, and analysis that only a real analytics solution, with advanced (spend) analysis, optimization, simulation, and reporting is going to provide. Don’t get fooled. All auction platforms give you in this day in age is a false sense of security. Sometimes an auction is the right way to go, but, most of the time, an auction (on its own), is not the answer.

Cost Reduction Strategies to Avoid

Cost reduction as a strategy is dangerous. First of all, a company that is too focused on cost might lose sight of value, which is what Supply Management is all about. Secondly, a company that is myopically focussed on immediate cost reduction is likely to make one or more of the following mistakes and actually increase costs in the long term.

Direct cost focus

This sounds like a great idea, since it’s where many organizations in manufacturing and CPG have the bulk of their spend, but the reality is that these are the categories that get analyzed year after year after year, while indirect categories fall by the way side. And the reality is that it’s much better to save 10% on 40 M then it is to save another 2% on a 100 M category. It’s twice the savings.

Landed cost focus

While it’s true that you can (theoretically) “book” a savings if a hardball negotiation gets you the same widget for $1, including transportation, that the organization used to pay $1.10 for, this is not really a savings if the widget is of lower quality and has a higher failure rate. If 15% break-down during the warranty window, when only 5% used to break-down, this has not only increased the average unit cost from 1.16 to 1.18 (in terms of functioning units), but tripled your warranty costs. If replacement costs turn out to be twice the product cost then, instead of paying an average of 1.20 per unit from a TCO perspective, the organization is now paying 1.30 per unit (from a TCO perspective) when the total cost of the lower quality product is calculated.

Year-over-year price reductions in multi-year contracts

This is my favourite example of cost reduction ridiculousness. Sometimes, anxious to meet the ridiculous mandate of 5% year-over-year cost reductions for the next three years, Supply Management organizations will try to negotiate three year contracts with year-over-year price reductions of 5% built in. And often they’ll exceed, and cost the organization approximately 15% more then if they just negotiated the best deal they could. Why? The supplier is going to have to make a profit each year it is in business. Since it’s likely not going to change the production methodology, the raw materials, or the labor that goes into making the product for the lifetime of the contract, the supplier knows that the price in year 3 has to be enough to be profitable. So the price it quotes in year 2 will be 5% more and the price in year 1 will be 5% more again in an attempt to insure it is still profitable in year 3. As a result, the organization ends up paying significantly more in the first two years than they could have paid by just negotiating the best, flat, deal possible. The right way to get year-over-year savings is to tackle different categories each year, not try to negotiate silly year-over-year savings in a single category.

Is Supply Management the Economic Cure Everyone is Looking For?

In a recent article over on the ISM site that asks “[if] your supply chain [is] ready for stagflation”, the authors state that the current economic outlook for the long-term is stagflation, which they also state is practically unavoidable because the drivers are difficult to reverse. However, they also state that it may be shortened if the right actions are taken.

What are the right actions? According to the authors, the period of stagflation may be shortened if investments are geared toward revamping and improving supply chains, a task which falls under the purview of Supply Management. Why will this help?

Consider the situation, as summarized by the authors:

  • we’re in a recession that is the deepest since WWII,
  • the NIA thinks we are headed toward hyperinflation, but the US Federal Reserve believes otherwise; regardless
  • a long recession builds pent-up demand for consumer goods, at a time when
  • interest rates are at a historical low,
  • unemployment is still high, and
  • the Federal Reserve Bank has pumped significant capital into the economy.
  • Historically, increased consumer spending pulls the economy out of recession, but
  • consumer confidence, and spending, usually improves with expectations of (near) future improvements in the economy. When this occurs
  • if companies cannot meet demand, we’ll see “demand-pull” inflation and
  • if inflation occurs, the Federal Reserve will likely increase interest rates.
  • Right now, inventories are too low and
  • manufacturing is experiencing significant cost pressures. Thus,
  • the outlook is low profitability for manufacturers and
  • low profitability and inflation will result in slow, or no, economic growth — stagflation!

Now consider what will happen if Supply Management is allowed to invest considerable dollars in revamping supply chains.

  • Increased efficiency and optimally balanced inventories will prevent the “demand-pull” inflation that is predicted to occur and
  • as a result, interest rates will likely stay reasonable.
  • Cost pressures will decrease as a result of re-balancing of production to minimize logistics costs, increase efficiency, and use more affordable materials which will result in
  • profitability for manufacturers increasing.
  • A resurgence of corporate faith in the economy will lead to more hiring,
  • which will renew consumer confidence, and since they will have more dollars to spend as a result of decreased unemployment levels,
  • spending will increase, releasing the pent-up demand for consumer goods, and then the
  • economy will rebound.

No stagflation. I think the authors of the piece over on the ISM site that asks “[if] your supply chain [is] ready for stagflation” are brilliant. Because, with a careful analysis, it really does look like better Supply Management, with investments in supply chain improvements across the board (which result in more job creation immediately), can pull the economy out of the funk it is in.