Elevated pricing - supplier cooperation gone bad

Today's Globe and Mail reports that the European Union (EU) has fined Otis, ThyssenKrupp, Kone, and Schindler, Mitsubishi Elevator some US$1.3B for colluding to fix prices in Europe (appeals expected). I expect a resounding silence from industry lobby groups on this one. Lobby groups like to be loud and clear about the value of working closely with suppliers, that "strategic partnerships" are more valuable than commercial relationships, and that buyers should trust their supply partners with more of a firm's value chain.

I agree ... but in the words made famous by Ronald Reagan "doveriai, no proveriai". On more than one occasion I have enforced a right to audit supplier invoices. The first time I did it was when I was working for CN Railways, the supplier was (and is) a Canadian subsidiary of a global "MRO" parts supplier.

The relationship was worth about C$12 million a year, mostly driven through a huge number of small dollar transactions. Work to integrate the supplier into our EDI system led the team to wonder about the quality of the data feed from the invoices (a polite way of saying that their pricing seemed wacked). We had the right to audit, and on 24 hours notice put a couple of internal auditors into the supplier's offices. We agreed to sample about 1000 invoices and share the results with the supplier. We found that roughly 50% of the invoices had pricing errors which pointed to our concern about the quality of their data system, when we also observed that about 83% of the errors were in the supplier's favour it suggested that we might also have an ethical concern about their behaviour. The difference between contracted prices and invoiced prices was roughly $1M (8% of the C$12 million in sales). For a railway that only made $75M in profit that year, it was pretty significant.

The very talented guys over at "The Buying Triangle" are working on this type of problem (and others). Here's how they describe a portion of their solution:

Analyzing costs of goods and services—the third node on The Buying Triangle—can
be difficult to validate without effective price discovery. After contracts are
negotiated, the work of determining whether savings are real or theoretical
still lies ahead. This is often complicated by factors such as:

* the best pricing may be for items rarely used much of what you buy may actually be off-contract
* you can't validate contract compliance because you can't produce a detailed breakdown of historical purchases

I suspect that some of the buyers who experienced "elevated pricing" in Europe got the "verify" bit right. What are you doing to verify your supplier contracts?

Cheers,

David Rotor

If we keep quiet maybe nobody will notice - good supplier cooperation

For cell phone companies in Canada it might seem that the Ides of March are a day early this year. But if they are feeling a sense of impending doom, they're doing a great job of keeping it to themselves. As I wrote back in December, wireless number portablility (WNP) is finally arrving in Canada on March 14th. You wouldn't know it from the industry's advertisements, as Catherine Maclean writes in the Globe and mail "The lack of advertising, however, shouldn't be surprising. Some observers predict the move could lead to an uptick in so-called churn, or customer turnover, as unhappy subscribers, who are wedded to their phone number, head for the exit signs."

I am all for the awkwardly named WNP, having seen it work to great advantage in other countries. I can also support the position cell phone companies are taking, none of them are advertising this pretty significant change in their industry but they aren't doing anything illegal, colluding, or misleading their consumers. Where am I going with this comment ... see my next post.

Cheers,

David Rotor

Common sense lease advice

Terrence Belford writing in the Globe and Mail today has an article on negotiating commercial real estate leases. Here are a few nuggets of good advice for any supplier negotiations, not just negotiations with your landlord.

* Don't begin negotiations with a threat
* Understand your supply market and what options/substitutions are real
* Consider what the other side wants to get out of the negotiations
* What can you bring to the table that is more valuable to the other party than it costs for you to provide - and vice versus

The article concludes with a pitch from a real estate negotiating service "In seven years, we have never had a situation where we did not save a client and in some case those savings have been considerable."

If you're thinking about using a service to do negotiations you should think hard about that quote. Do you have the expertise and market experience to do as well as a firm that has been doing this for seven years? Consider that your internal staff haven't been held to the same standard of having to earn revenue from their expertise that a service provider is required to meet. On the other hand, also take a hard look at how they define savings and what strategic value your company expects to receive from the negotations that are not captured by the term "Savings".

This one caught my eye

The Economist has published a book review (subscription required) that caught my attention this morning. “Firing Back”, by Jeffrey Sonnenfeld and Andrew Ward, on how executives can rebound from being sacked. Here's an interesting section:

There is a five-point plan, which begins with “fight not flight”: it is
crucial not to become so preoccupied with coping with failure that you fail
to pursue a new career seriously. The story is told of how Mr Dimon decided
to seek out his former mentor, Sandy Weill, who had fired him from
Citigroup, a year later. “I wanted to get this event behind me so I could
move on. I made my own mistakes. I acknowledged I was partly to
blame.” The ousted boss also needs to “rebuild heroic stature”, prove his
mettle to regain credibility and rediscover his “heroic mission”. Much of
this boils down to reputation management. Despite Mr Dimon's admirable
private candour, the authors urge executives to devise a plausible narrative
about their failure that includes “clearly denying culpability, shifting
responsibility for the mishap, reducing the offensiveness of the act, giving
the appearance of reasonable behaviour and offering acceptable motives.”
Head-hunters may be a more important audience for this story than intimates
or the broader public. Some sources of failure are better than others: get
fired during a merger, a political clash or over a strategic disagreement,
and you have a two-thirds chance of returning to corporate leadership within
two years. Best avoid being sacked for poor performance, unacceptable
personal conduct or illegal behaviour, however.

Cheers,

David Rotor

Do you understand PPP?

There is an interesting discussion going on over at Marginal Revolution on the value and definition of Purchasing Power Parity. If you think you know what it is and how it impacts your supply contracts you might be in for a surprise or two.

Cheers,

David Rotor

Blackstone's Office Properties

In November I wrote about Blackstone's bid for EOP. It closed today at $39B. My advice still stands, they should take a hard look at their SG&A. I also recall something I had forgotten about back in November. When EOP was a client, a Vice President of Procurement had the last name "Borg" (I did a cursory check on the web-site and can't see if he's still there). It's a funny last name. For you Star Trek fans, ok, it's a little funny. For us purchasing types Borg means "B"uying "org"anization. Juvenile yes, but it still brings a smile to my face.

Cheers,

David Rotor

Limits of Sourcing - Part Deux. PI gets e-sourcing tool.

Back a couple of weeks ago I was thinking (and posting) about the limits of strategic sourcing. How small can a company's spend be and still benefit from sourcing? The challenge was to source for a client with less than $10M in SG&A across all categories.

The obvious constraint is the cost to source versus the benefit, and the relative market power generated by volume versus market knowledge. If one is trying to improve productivity deploying technology is an obvious solution. In this case, e-sourcing technology, "e-auctions" or "reverse auctions" is the technology of choice.

For those who are either not procurement types, or if you've been sitting in a three-bid cave for a few years here are some indications of the growth of e-sourcing technology.

* OGC, the UK government's "management board" is providing e-sourcing across many of their departments:

41% cost reduction in IT hardware costs.
http://www.theregister.co.uk/2006/06/08/public_sector_eauctions/

Here some background info on the OGC program.
http://www.ogc.gov.uk/documents/cp0025.pdf

* GSA, the US government's "management board" is also providing e-sourcing for the US government.

Fed-bid was awarded a five year contract to perform e-auction
http://www.fedbid.com/dictator/media/68/200701_general_overview.pdf

Here they announce they have conducted their 10,000th auction.
http://www.fedbid.com/news/46/ 10,000th reverse auction.

* Aberdeen, the analyst firm, has just released a report on advanced sourcing. Here's a quote "With an adoption rate within the Fortune 500 approaching 100%, eSourcing is a widely accepted business practice that can generate compelling benefits for its users."
http://www.aberdeen.com/c/report/research_briefs/RB_Advanced%20Sourcing_AB_3804.pdf

* ELP, European Leaders in Procurement, the magazine, explains why e-sourcing is good for suppliers.
http://blog.europeanleaders.net/procurement-blog/2006/10/4/why-e-sourcing-is-good-for-suppliers-part-i.html

* Here's a press release from my old boss. Minister Fortier bucks the trend of the UK government, the US government, and the vast majority of the Fortune 500 by making e-sourcing off-limits (ignoring the fact that the Canadian government has been conducting e-sourcing for close to ten years).
http://news.gc.ca/cfmx/view/en/index.jsp?articleid=237679

* Supply Chain Digest, the magazine, identifies e-sourcing as the #1 strategy for supply chain management in 2007
http://www.scdigest.com/assets/Reps/SCDigest_Top_10_Strategies_2007.pdf

Back to the $10M sourcing problem at hand. Let's assume for a minute that 30% of SG&A in 12 categories is addressable for sourcing - leaving $3M - and with a savings estimate of 10% that means the company could enjoy $300,000 in savings if sourcing can work on this small scale. What will it cost to use e-sourcing to attack those twelve categories?

For an industry that is fundamentally about pricing transparency to drive competition, it's remarkably difficult to answer this question. My own experience suggests that you can easily negotiate prices in the $2,000-$10,000 range for a single event. At the low end, this could work for the client ($24,000 cost against $300,000 benefit). At the high end, the benefits would appear in out-years. Alternatively, you could try and run it on one of the "supplier pay" models such as www.sorcity.com, though the low spend may not be attractive for the auction provider.

And finally, the approach I'm taking a hard look at. Tender System has released an open-source e-sourcing tool. I've just installed it on the Procurement Investor web site and will be configuring it over the next few days. I'm intending to also make it available to Procurement Investor readers in the near future.

Cheers,

David Rotor