Category Archives: Economics

Capital Costs are Going Up. Can Your Supply Chain Handle It?

The McKinsey Quarterly just published a great article on “how the growth of emerging markets will strain global finance” (registration required) that should be read by every CPO who doesn’t work for a mega-corporation with a large cash balance. The article will help them understand what’s keeping the CFO up at night and why the CFO, who already has to deal with Basel III, might be afraid to invest in long-term capital projects (or, at the very least, have difficulty committing the capital).

The article points out that when you combine low savings rates in developed economies, decreasing savings rates in the more mature emerging economies, the increasing expenditures required to support the aging population in developed countries (that will further reduce savings), and the growing need for capital-intensive investments in infrastructure in the new emerging economies, in less than 20 years there will be a significantly greater need for investment in the global marketplace than there will be investment dollars available. When you combine this increasing demand for capital with the looming threat of increased inflation, and factor in the increased risks associated with short-term funding, it quickly becomes clear that interest rates have no where to go but up, especially since these rates are now at their 30-year lows. At the very least they will return to their 40-year average (which is about 150 basis points above current rates), but they could rise even higher.

As a result, capital for supply chain infrastructure investments could soon be in short supply. This means that if your supply chain is aging and needs significant infrastructure upgrades in terms of facilities or vehicles, the last thing you want to do right now is extend end-of-life (planning) too far into the future if a costly upgrade is inevitable. At the very least you want to start planning and analyzing different upgrade cost scenarios that factor in different (potential) costs of capital so that you’ll know how much capital the supply chain upgrades are going to require and at what point it becomes too expensive. Then you will be in a good position to work on securing the capital before it’s too late.

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Time to Stop Worrying About China

Yes they’re the number two economy and yes they will reclaim their spot as the number one economy in thirty (30) to forty (40) years, but they’re not worth all the attention they’re getting. As per this recent article in The Economist on Chinese Acquisitions, China owns a mere 6% of global investment in international business. That’s less than 1/15th. Compare that to Britian’s stake in international business in 1914 or America’s stake in international business in 1967 when they both held about 50%, or 1/2, of global investment in international business, and you see that there’s really nothing to worry about.

Since most developed world markets have rules in place that insure that no global investor can divert business away from the home country or export trade secrets or compete in a monopolistic way, the rules we have in place for foreign investors right now are good enough. There’s no point wasting time and money developing special rules for China, especially when most of our economies need our attention as it is. And as far as our supply chain is concerned, how about we spend the time and effort making sure they are adhering to our regulations and safety protocols instead? After all, even when they become the dominant economy, they’re not likely to be more than 20% of global GDP (especially since the rest of the BRIC countries are expected to increase significantly in GDP as well) or control more than 20% of global investment. And while 20% is significant, it’s far from majority control. Time to stop the much ado about nothing and get back to business.

Is Your Supply Chain Future In India?

As per this recent article in Digit Chanel Connect on “Moving Up the Supply Chain”, IDC India estimates the total Indian SCM solutions market will reach $132.6 Million in 2011. This might not sound like much, but, in relative terms, it’s the equivalent of a $1.6 Billion dollar market! (In 2009, the GDP of India was one twelfth of the GDP of the US.) And it’s still growing!

India’s Big 6 Consultancies are already making massive inroads into the global market. Many companies are making the SWITCH — Satyam, Wipro, Infosys, Tata Consultancy Services, Cognizant Technology Solutions, and HCL — and the current Big 6 Providers are being PACKED (PriceWaterhouseCoopers, Accenture, CapGemini, KPMG, Ernst & Young, and Deloitte & Touche) in. The major players might be SAP, Oracle, and Aspen today, but it won’t be long before the ABC Procure’s, Algorhythm’s, eBiz Global’s, Griha Software Technologies’, and Zycus‘s become the next major players in the Indian SCM space, and not much longer before those companies, and the next generation, make an even bigger impact on the global e-Sorucing and e-Procurement marketplace.

Furthermore, as Ravindra Sharma, General Manager of Ariba India, says: “With India poised for decent growth, many of the firms are proactively setting up [a] supply chain infrastructure which can help them grow rapidly and profitably. Many of these firms have global business aspirations and are benchmarking themselves with global organizations in various aspects including business processes, practices and technology“. As a result, deployment of SCM solutions is definitely increasing — and Indian companies are working hard to fill the surging demand now that Indian corporates have ‘tasted’ the efficiency of SCM solutions and now believe it to be a vital component of their business readiness plans.

In other words, while most of your technology options today will likely be US companies, or European offices with a strong US presence, it might not be long before many of the options on the table are Indian operations. But with the cloud and 24/7/365 service levels, will it really matter?

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Why Aren’t Reverse Auctions More Commonly Used?

A recent blog post over on Procurement Excellence asked “why aren’t reverse auctions used more by procurement people”? According to the article, it’s usually because:

  • procurement people sometimes lack the confidence to run them
  • procurement people are often scared of running auctions because they might expose how badly they are currently buying

Fair enough. They do require confidence and if you’re really doing poorly, they’ll expose that. But these aren’t the only reasons, and, I’d bet, not even the most common reasons. What about:

  • procurement people are scared suppliers won’t participate

Suppliers can be as scared of, or more scared, of an auction as a buyer. And for many reasons. They might be the incumbent with a history of overcharging. They might be a first-time invitee and have the perception it is only being run to drive down incumbent pricing. They might feel that it won’t capture the full value of their offering. And so on.

And these reasons only really apply to procurement people who probably haven’t run reverse auctions (or at least those who haven’t run a reverse auction successfully). There’s also:

  • experienced procurement people know that sometimes a reverse auction can increase prices and
  • smart procurement people know that it’s not always the right option

For a reverse auction to be successful, a number of conditions have to be right. There have to be enough suppliers willing to participate who want the business. The current pricing has to be above market average. The buyer has to be willing to award to the bidder with the lowest (weighted) bid and the suppliers have to perceive that. Either the majority of the cost has to be landed cost or the true cost needs to be easily defined as a weighted multiple of a (supplier’s) bid. If these conditions aren’t met, not only could costs not decrease, but they could increase. For example, if there were only three suppliers, in collusion, in a supplier’s market where demand exceeded supply and the current market price exceeded the price the buyer was currently paying, costs might increase substantially!

Furthermore, a truly smart buyer knows that reverse auctions aren’t always the answer, especially for strategic materials, components, or services. Not only are there some things that you can’t auction, but there are some things you shouldn’t auction, especially if your spend is high enough where you have leverage with your preferred suppliers. If you do a spend analysis and find out you’re spending 50M with your preferred temp labor supplier, it’s pretty easy to get at least 10%, if not 20%, savings if you show them the numbers and threaten to take your business elsewhere. Who’s going to give up 30M to 40M worth of business in a down economy? And if you’re primarily contracting security guards, janitorial services, and seasonal warehouse packers, should there really be a salary bell curve? In these situations, someone making above the mean is not going to be more effective than someone making below the mean.

Finally, a good procurement pro knows that there are only two technologies in the tool-kit that consistently give double digit returns on average, regardless of the economy — and those tools are spend analysis (which can enable leveraged negotiations) and decision optimization. While it’s true that a reverse auction can generate double digit savings in the right situation, that situation is not nearly as common as some vendors will have you believe. And that’s why more procurement pros aren’t running reverse auctions. They’re not always the right choice.

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