Category Archives: Finance

Regulatory Damnation #34: Tariffs

While taxes alone are not damning, as taxes, like death, are one of the only two certainties in life, tariffs, on the other hand, are one of the ongoing nightmares of the Procurement world. Tariffs make the complete personal income tax code of the United States look like a kindergarten book.

For example, the current HTS (Harmonized Tariff Schedule) of the United States is 3,536 pages. And that’s just the US HTS code. The 2007 LIGIE for Mexico is 684 pages, and there have been hundreds of pages of amendments since then.

With 196 countries in the world today, extrapolating, that’s over 200,000 pages of HTS / HS (Harmonized System Code) classifications that an organization needs to be on top off to determine international import and export duty rates. But that’s just the tip of the iceberg. It’s not just keeping track of rates, it’s figuring out the rates that apply. For example, let’s say you want gloves, is it:

    4007.11.70 Leather - full grains   - glove and garment
    4017.12.70 Leather - split grain   - glove and garment
    4107.19.70 Leather - whole hide    - glove and garment 
    4017.91.70 Leather - other         - glove and garment
      ..
    4023.10.40 Apparel - articles      - gloves, mittens and mitts
    4203.29.XX Apparel - cowhide       - gloves
      ..
    6116.10.08 Gloves  - coated        - other
      ..
    6116.92.08 Gloves  - cotton        - other
      ..
    6116.93.08 Gloves  - synthetic     - other
      .. 
    6116.99.35 Gloves  - other textile - other
      ..
    6216.00.08 Gloves  - impregnated   - other
      ..

there are so many (dozens upon dozens of) classification of gloves, that it’s hard to find the right one – and if you pick the wrong one, and especially if you pick the wrong one with a lower tariff rate, then your organization is at risk of significant fines and penalties.

So how do you deal with this? There’s only one way — get a trade market intelligence solution which is kept up to date by people around the globe as classification updates and rate changes come up and easily searchable by the average Procurement professional who is not an expert in H(T)S code structures. There aren’t a lot of options, but SI recently covered one company, Integration Point, that has been building such a solution for almost 10 years. Why do you need a third party? Integration Point, which maintains a global content team, made over 2 Million updates to their global H(T)S code database in 2014 in an attempt to keep up with the never ending string of updates that are regularly released by countries around the globe. (Some countries release updates on a weekly basis. For example, Brazil once updated its HS code 80 times in one year.)

Economic Damnation #05: Currency Strength

As indicated in the prologue to this series, there are dozens upon dozens of challenges being thrown at you as a Procurement professional on a daily basis. Causing you nothing but grief and agony, these damnations collectively do nothing but divert your attention from critical strategic planning, (should-cost) modelling, and supply assurance.

Today we are going to discuss damnation #05, currency strength — one of the ten economic damnations that we will cover before this series is over. This damnation is particularly relevant with the recent volatility in the Ruble, Renminbi (Yuan), and the petro-dollar — which might be used as a hedging strategy in some organizations.

Currency fluctuations can quickly destroy the best laid sourcing plans when sourcing internationally from countries that use a different currency, even if the contract is being executed in the currency used by the buyer.

In the situation where the contract is being executed in the currency used by the buyer, if that currency devalues against the currency being used by the supplier, then the supplier may not be able to afford to honour the contract without risking bankruptcy (as the supplier’s costs would exceed their sales). In this case, the supplier may simply cease to honour the contract.

In the situation where the contract is being executed in the currency used by the supplier, and if that currency increases significantly in value compared to the buyer’s currency, then the buyer may not be able to afford to buy from the supplier (as the buyer’s costs would exceed what the customers are willing to pay) and may be forced to break the contract (and risk the ramifications).

In either situation, there is a disruption in supply and the potential for significant financial and legal ramifications down the road. And this is one damnation that is never going away as currencies never remain stable. And while it will forever damn us, it is not always impossible to predict when currencies are likely to fluctuate.

How? Through the use of Purchasing Power Parity (PPP), we can determine when a currency is undervalued and when it is likely to rise in the future or when a currency is overvalued and when it is likely to fall in the future. It’s not perfect, but it’s better than flying blind. (For a good definition of PPP rate, review Dick Locke’s classic post on Undervalued Currencies, Part I).

So how do you determine PPP? One way is to simply look them up on the World Bank site. And how do you determine if a currency is over or under valued? You compare the official exchange rate to the PPP rate. If the PPP is (significantly) greater than the exchange rate, then the currency is undervalued. But if the PPP is (significantly) less than the exchange rate, then the currency is overvalued. How much? Divide the rates to get a percentage.

So how do you put this to use? Since floating currencies don’t always settle near the PPP rate, which some analysts are prone to believe, you look at historical variations and see where the trend over time is. If the currency is undervalued by 30% but the historical trend is that the currency is only undervalued by 20%, then it is likely that the currency is going to rise and that should be taken account in one’s projections. But if the currency is undervalued by 15% and is historically undervalued by 25%, then it is likely that the currency is going to fall. (For a more detailed explanation and example calculations, see Dick Locke’s classic post on Undervalued Currencies, Part II.)

Now, this won’t account for the situations where one country, like the US, is intentionally lowering the value of a major market resource or currency basket, like the petro-dollar, in the hopes of decreasing the value of another market resource or currency, like the Ruble, in the hopes of weakening an economy, like Russia, as these situations can only be detected by geopolitical (trade) monitoring (which will be discussed when we cover damnation #25, among others), but it will give you a much better understanding of relative currency strength and how the currency value is likely to change over time based on historical trends.

Procurement Trend #07. Supplier Pre-Payment

Four anti-trends remain. We can count them on one-hand’s worth of fingers, but like LOLCat, we feel more compelled to provide examples of how far beyond retro the futurists really are when they provide us examples of trends that anyone who bothered to poke their head over their cubicle wall thirty years ago (or outside the yurt three thousand years ago) would have noticed. However, we’ll leave their bitter humiliation for LOLCat, who is obviously received very little enjoyment from this series, but still found the time to point out how LOLCats have been sustainable at least since the first corrugated cardboard box was created and instead focus on dispelling the myths the futurists continue to propagate.

So why do these Rip van Winkles keep pushing upon us trends from yesteryear? Besides the fact that some of them obviously spent the best part of last decade napping, probably because they look around, see the laggard organizations still caught in the muck, and assume they can still sell last decade’s leftover snake oil in today’s marketplace. Why do they think Supplier Prepayment is today’s cure?

  • suppliers in emerging and even recently emerged countries may not have easy access to short-term financing
    which may mean that payday loans or family* loans may be required and as a result
  • interest rates vary and suppliers’ interest rates may be much higher than yours
    and costing the supplier, and thus you, 3% or 4% a month, not per annum
  • early payment can be the difference between blood red and black
    because with 36% APR loans, they double every 24 months a borrower doesn’t make a payment

So what does this mean?

Know the True Cost of DPO

How much is 30 day, 60 day, 90 day and 180 day DPO, from the time the supplier starts producing your order, really costing the supplier and, hence, since that costs needs to be built into their price, costing you?

Know the True Return on DPO extension

If the only reason to extend DPO is to get 2% annual interest in a short-term cash deposit, and this extension of DPO costs your supplier 24% annual interest, are you really making money off of this? If, however, you have the 1 in 100,000 situation where paying on time requires a loan from your bank at 12% and your supplier is on-shore, being government funded, and getting development capital at 6%, then in this case it actually makes sense to extend DPO until you are in a better position as it only increase the supply chain cost 6% instead of 12%. But this is probably a 1 in 100,000 situation.

Know what alternative investments net

Decreasing DPO might decrease supply chain cost, but if that investment requires smaller LTL (Less Than Truckload) orders and faster inventory turnover, this could cost more in the long run as FTL (Full TruckLoad) is cheaper and stock-outs cost revenue. Throw all the numbers, good and bad, into an optimization model and figure out what the best choice really is. Sometimes it will be early payment, or even pre-payment, of the supply base, and sometimes it won’t.

* Not their family, the family, capiche?

It’s Illegal to Burn Money, But Yet Your Organization Does It Every Day! (So Find Out How to Do Something About It!)

Title 18, Section 33 of the United States Code says you shall not mutilate, cut, disfigure, perforate, unite or cement together, or do any other thing to any bank bill, draft, note, or other evidence of debt issued by any national banking association, Federal Reserve Bank, or Federal Reserve System, with intent to render such item(s) unfit to be reissued and if you do, you can be fined or imprisoned for up to 6 months. But yet, every day, organizations everywhere collectively flush billions of dollars down the drain, overpaying suppliers, including foreign suppliers, millions of dollars that can not be recovered and reissued by the organization for other business purposes.

If it wasn’t for the fact that the vast majority of these organizations don’t intend to overpay and waste money, since this money (and evidence of debt) flows through the American banking system, I would otherwise be inclined to argue that, technically, this gross incompetence in management of corporate funds is criminal.

For proof that the average organization wastes money, we simply have to look to the audit recovery industry which recovers, on average 1% to 1.5% of annual spend. And, typically, this is just what they can find with a quick, mostly manual, review of the top n suppliers that account for 2/3rds (66%) to 3/4ths (75%) of external organizational spend using a very loose interpretation of the 80/20 rule. And that’s just overspend. What about spend that should never of happened in the first place (because it was off-contract and 15% higher than contracted rates)? Or unrecoverable losses due to a key supplier not having mandatory insurance policies in place? Or gross violations of the T&E (Travel & Expense) policy (that border on criminal malfeasance) where the VP of Sales decides that a dinner costing 2K / head at the local strip club is a valid use of the organization’s P-Card?

But most of these situations are easily preventable by a Procurement system that is designed to not only enforce compliance, but make it easy. To find out how, check out Sourcing Innovation’s New White Paper on The Procurement Marketplace and the Power of Compliance (registration), sponsored by Vinimaya.

CPOs Deserve to be in the C-Suite

And the general belief is that because Supply Management is so important to organizational success, CPOs should report to the CEO. And while this should be the case in theory, should it be the case in practice?

According to a recent study by A.T. Kearney (as highlighted over on S&DC Exec) conducted in association with CIPS and the ISM, only 10% of procurement functions have established recognition with their CFOs regarding how procurement contributes value and that the benefits are real and measurable. Ouch! Reading this make one wonder if maybe the CPO should be reporting to the CFO.

Why? Because if the CPO is a direct report, it might convince more CFOs to spend more time trying to understand the ways of Procurement and convince more CPOs to spend more time trying to understand the ways of Finance. The joint effort might result in more CFOs and CPOs coming to a joint understanding, which might result in more CFOs understanding the true value of Procurement.

Right now, as per a recent Cap Gemini Survey (available at this link), 20% of CPOs report to Finance. It’s unfortunate that we don’t know how many of these CFOs are among the 10% of those that understand the value of Procurement. Because if the majority of CFOs who understand the value of Procurement were those who had the CPO as a direct report, then the answer would be simple. Have the CPO sit at the table but report through the CFO on a daily basis until such time that Finance understands the true worth of Procurement. However, if the percentage of CFOs with direct CPO reports who understand the value Procurement brings is only in the 20% range, then having the CPO report to the CFO makes no difference.

Any thoughts on the issue?