Category Archives: Sourcing Innovation

So You Need a Sourcing Platform That’s Next-Gen To You. Where Do You Start? Part I

There’s no single right answer or easy answer here. It’s very situational.

Some consultants will always tell you to start with Procurement because:

  • you get manpower and transactional savings immediately
  • you will get the majority of your spend properly categorized in ONE system (which will enable better spend analysis and opportunity selection later)
  • you will stop overpaying and duplicate paying invoices with 3-way matching and reduce recovery requirements
  • you will reduce cycle times and be able to take advantage of early payment discounts
  • and so on …

Some consultants will always tell you to start with Sourcing because:

  • you can invite and compare more supplier bids with modern RFI tools
  • auctions are a great way to realize a quick category price reduction
  • timeline reductions allow you to source more spend
  • portal-backed SIM makes it easy to keep track of suppliers and contacts with up to date information
  • etc.

But this doesn’t take the chicken and egg situation into account.

  • you can’t identify significant savings without a modern optimization-backed platform-backed sourcing solution that allow you to identify new opportunities, which means you need to start with a Sourcing platform if you need savings fast
  • but you can’t identify the best categories without good data, which is captured in a good e-Procurement/P2P system, which means you need e-Procurement to capture the data you need to identify the right opportunities (using spend analysis in the sourcing platform)

Or the fact that the biggest savings opportunity for your particular organization might be a best-of-breed niche SRM or CLM solution due to your biggest savings opportunities lying in supplier development or compliance.

So where do you start? Stay tuned for Part II.

For Those Who Recently Adopted Sourcing, Start Thinking About Next Generation Sourcing Now!

SI has been about next generation sourcing since the day it began. No matter how good you think you have it now, it’s not good enough. Why? Most of you are still on last decade’s sourcing platforms which, especially if you never had anything like them before, is a great start (and maybe beyond your wildest dreams if you were in e-mail and spreadsheet world), but not good enough. What you are going to find out, as SI told the Procurement leaders seven years ago today in its post on Next Generation Sourcing, all good things come to an end.

As we noted for those of you with first generation and early second generation systems,

  • Once you institute RFX, the manpower savings from automating bids can only be claimed once.
  • By the time an organization gets to the third auction, there are no more savings to be had as the fat from supplier margins has been squeezed out.
  • Once the allocation has been optimized across the supply base in a way that minimizes unit costs, transportation costs, (interim) storage costs, etc., re-running the optimization won’t lower costs further unless something changes — such as the identification of a new supplier, an alternate material (that is cheaper), additional demand (that increases the economy of scale), or a more powerful optimization model is provided.
  • Once contract management and monitoring is put in place and no invoices are paid that are not for delivered, defect-free products, at contracted rates, there is no little on-contract leakage to be stopped.
  • Once controls are put in place to stop off-contract purchases that should be on-contract (through integration of the e-Procurement system with the Contract Management system), there is no little off-contract leakage to be stopped.
  • Once spend analysis has identified all the opportunities, the savings won’t actually materialize until something is done about them. This something cannot be appropriately identified unless the appropriate information is available to the knowledge worker

And, more importantly, for those of you with later second generation systems:

  • Once a SIM with a powerful supplier portal and information / (compliance) documentation monitoring and alerting system is put in place, there is no additional time savings from information maintenance offloading.
  • Once a SPM which automatically collects organizational data and metrics is put in place, there is no additional time savings from automating supplier scorecard production.
  • Once a SRM with proper corrective action requests / corrective action monitoring and integration system is put in place, there is no additional time savings from quick-and-easy semi-automated resolutions.
  • Once an audit recovery system is put in place that not only 3-way matches invoices but identifies when rebate or discount targets are hit and automatically applies the discounts to current and future invoices, there is no more savings from high-priced audit recovery services.
  • Once integrated contract negotiation and e-Signature is implemented, there is no more process time savings from being able to track all updates by both parties and do sign-offs quickly.
  • … and so on

At some point, your year-over-year returns will start to trail off … somewhere between the three and five year mark, depending on how much spend you are able to put through managed sourcing events every year and how much you are able to use the system to support it. So don’t stand still. Start identifying your biggest weaknesses and looking for the next generation system to address them when the opportunity costs of not taking advantage of the opportunities you are missing gets too high.

So where do you start? Stay tuned.

How Do You Find Hidden Costs?

We all know that there is never a fixed arithmetic formula between the cost of producing, and transporting, the goods and services sold to us and the prices charged for them … sellers charge what they can get, and if we don’t do a good job of figuring out the true cost, which can be hard to do, chances are they are building in a hefty margin.

But the margin is only one hidden cost. There’s other hidden costs baked into the COGS by the supplier, some of which even they may not be aware of. But if you want to bring costs down, you have to find them. So where do you look?

Start by investigating each of the main production costs:

  • raw materials — what are your T1 suppliers paying to the T2 suppliers
  • energy — production always requires energy … but there isn’t always one rate
  • labour — if there is temp labour / contract labour involved, is it market rate
  • overhead costs — facilities, financing, etc. — these could be fixed, or they could not … for example, if the supplier has to borrow to fund operations until they get paid, what interest rate are they paying … and how does it compare to your rate? might be cheaper for you to pay them early in exchange for a discount that exceeds your cost of capital

That’s how you them. So what do you do next?

Come up with a plan to address any costs that look high:

  • if material costs are too high, can you buy on behalf of suppliers at a better rate? can you find alternative materials?
  • if the market is deregulated, can you help the supplier identify a better option? are energy requirements so large a supplier would do better off with its own plant? should you invest in it if there are multiple suppliers in the region paying absurdly high energy costs?
  • should you share labour negotiation and management best practices to help your supplier keep labour costs down
  • if suppliers have a high cost of capital, help them out … reduce their cost, reduce yours; maybe you can identify facility upgrades that would save them money

It’s not as easy as it sounds, but it’s not that hard either. Just takes data gathering and analysis.

How Should You Define Procurement Success?

This question is encased in a nut that’s quite tough to crack. We hinted at the importance of defining it three years ago in our post that asked how do you define Procurement success which noted that if you consider the art of the Strategic Sourcing Process, the Category Management Process, or the Contract Management Lifecycle, you [not only] see that they all start about the same at a high-level but that a key requirement of each step is an acceptable definition of success.

This means that if you want to be successful, you need a good definition of success but what should it be?

If you ask the CFO, she will say it should be cost savings! Reduce the outflow!

If you ask the Chief Engineer, it should be the best quality and reliability money can buy!

If you ask the Production Chief, it should be rock solid supply availability.

If you ask the CMO, it should have the most unique gee-whiz features on the market for the biggest marketing splash.

If you ask the VP of Sales, it should be the product that comes with the most value-adds so they can command the greatest price.

And so on.

On SI, we have repeatedly said the definition of procurement success should always be the outcome that brings the most value to the organization, but this can be hard to define when there are a number of competing viewpoints on what value is.

However, we can define Value as the outcome that balances the tradeoff between the goals of the respective stakeholders for maximum return against an agreed upon value scale that normalizes a dollar of savings (for the CFO) against a reliability metric (for the Chief Engineer) against an expected availability metric (for the Production Chief) against a feature differential against the market average (for the CMO) against a value-add differential (for the VP of Sales) [etc].

Now, you might be wondering how you do that? The answer is simple: define an expected dollar value. It’s not as hard to do as you think (as long as you have the [big] data and the model and the software to calculate it)!

The CFO metric is easy, a dollar of savings is a dollar of savings.

The reliability metric is not that much harder. A failure rate of 90% vs 93% during the warranty period has an incremental cost equal to 3% of the units times replacement cost (which is base product cost + processing cost if outside of supplier warranty or processing cost + return cost if inside supplier warranty) and this cost can be amortized per unit.

The supply availability metric is involved, but still easy to define. First you have to calculate an expected chance of disruption based on it. Once you do, the cost can be approximated as follows: (% chance of disruption * % length of disruption x cost per day of disruption) amortized by units. If there is 10% chance of disruption, then you expect one every 10 years, for the estimated length of time, at the estimated cost per day, and amortize that cost over each unit purchased each year. Not perfect, but a good approximation. To find the conversion from expected availability percentage to chance of disruption, you mine your data and extrapolate the multiplier. Easy peasy (with a modern cognitive or deep analytics platform).

The CMO metric is tricky. Just how much better is that gee-whiz feature? Probably not nearly as important as the CMO claims. To figure out an approximate dollar value per unit here, you will have to mine historical data to see the incremental marketing value from the company’s “most differentiated” or “feature rich” products compared to its “least differentiated” or “feature poor” products as compared to the estimated market share each product obtained. If “feature rich” products typically command an extra 10% of market share, each unit is valued at a premium of 10%.

The value-add is easy — mine the historical data to extract the dollar value of each “value-add” available to the company.

Then, to find the optimal trade-off during a sourcing event, build a multi-objective optimization model that maximizes the overall value generated from these goals.

In other words, what used to be downright impossible is now pretty straight forward with strategic sourcing decision optimization and cognitive sourcing.

The Snares of Sourcing

Sourcing is the key to supply management success, but only if it is executed in an effective manner. Otherwise, there is a risk that the sourceror will make a decision that makes the situation worse, not better.

For sourcing to be effective, it has to add value. Otherwise, there is no benefit to sourcing compared to a procurement spot buy. Value can come in many forms, including, but not limited to, better quality, lower cost, more value-added, services, and guaranteed availability. However, especially from the CFO’s view, lower cost and supply availability are generally the priorities as bottom line improvements depend on cost reductions and sales for profit.

But for sourcing to be effective, the sourceror has to avoid the traps, traps which come from their lack of market knowledge, supply market knowledge, and e-Sourcing expertise. Specifically, if a sourceror has:

  • lack of market knowledge

    and does not understand whether supply exceeds demand or demand exceeds supply, the sourceror can choose the wrong event type — an auction when supply is scarce, a strategic negotiation with the incumbent when supply is plentiful, and so on

  • lack of supply market knowledge

    and does not seek out more knowledge, she could pass over inviting the best suppliers to the event or eliminate supplier with seemingly high or low price points without understanding the additional value they can bring with commitment and buyer expertise

  • lack of e-Sourcing expertise

    and does not know the ins and outs of refined sourcing process and the best way to engage suppliers, extract detailed cost models, or determine the right supply base split, inferior decisions will be made

So how can the sorceror avoid the traps? Especially if she does not have the knowledge? Cognitive sourcing platforms that can fill in the gaps.

A good cognitive sourcing platform will:

  • provide the buyer with up-to-date market knowledge that allows a user to always understand the supply/demand balance or imbalance in the market
  • provide the buyer with a good overview of the current and potential supply base
  • provide the buyer with the typical sourcing strategy for the category and (supply) market dynamics to help the buyer make a decision

Will the cognitive platform always be right? No. But it will be most of the time, and that will help the buyer make better decisions more often. And avoid most of the sourcing snares.