Procurement Investor

Purchasing technology company that "gets it"

2007-10-22T19:25:00.000-05:00

Dave Stephens, CEO of Coupa Software, an open source procurement software provider, has just announced that they are providing "transparent pricing". Clearly Dave thinks he has a competitive advantage and I love his line "I’m challenging the rest of the industry to follow suit. So far, there haven’t been any takers." In the procurement world market knowledge is key to writing good contracts. The cost of engaging software providers in lengthy dances of displaying enough interest in order to get a firm price quote hurts both buyer and supplier by adding costs to both parties. I applaud Dave for taking this position; his software solution is worth looking at too.

Cheers,

David Rotor

Super Crunchers ...

2007-10-14T12:53:00.000-05:00

These two are the super crunchers in my life ... followed by what they thought of Ian Ayres' book ... I'll let you know what I think about it myself if there is enough left to read ...

Airfare increases

2007-09-05T10:49:00.000-05:00

According to Bloomberg, several major US airlines increased their fares starting 31 August. Southwest kicked off the price increase with $1-$10 increase for each flight (up to $20 roundtrip). The usual suspect, jet fuel price increases, are being blamed.

Buying the top job

2007-09-05T07:03:00.000-05:00

The new chairman at Renault F1, Bernard Rey, has been Renault's "go to" purchasing guy for about a decade. He was appointed Renault's International Chief Purchasing officer back in 1998, and then followed Ghosn to Nissan where he drove a program to lower Nissan's purchased expenses by 20%.

Hat tip to Grandprix.com

How much for an iPhone?

2007-07-03T09:29:00.000-05:00

Over at Gizmodo they've posted a ton material on the iPhone. Here's one (they didn't write it) about the material cost of the iPhone. Bottom-line is an estimate of $200. "What if costing" is fundamental in procurement, and one of the main tenets of the technique is to understand what bits of the cost equation are you estimating and what, if any, relationship that has to pricing. With the iPhone retailing at $600 give or take, I would suggest that "what the market will bear" factored more heavily in the pricing discussions than the material costs. But even so, the guys at Giz suggest that consumers should be a bit taken back by Apple's profit. The real cost of the iPhone is probably somewhere north of $400, even without allocating any development costs to the product.

Material cost
Logistics (transportation, handling, inventory)
Retail costs (labour, facilities)
Advertising & Marketing
Support costs (how do I activate this dang thing?)
Warranty costs (shipping, handling, labour, parts)
etc, etc

Rough numbers, this type of equipment often runs about 50% material and 50% other costs (again not counting any development costs). Is $600 a fair price for a $400 phone? My buddy Mike says yes, and who is a lowly buyer to argue with that?

Cheers,

David Rotor

What's the number?

2007-06-25T10:02:00.001-05:00

I've negotiated a fair number of contracts over the years. Most of the time its a simple exercise of determining the how much will one pay for a good or service. But when the transaction is extended in time or over a number of payments even the simplest transaction can become difficult to conclude. I've found that one of the biggest issues is a disconnect between what is emotionally fair, and what is numerically reasonable.

Let's take a car purchase. A dealer has it listed at $38,789 after some negotiation you settle on a price of $35,600. The dealer then asks if you would like to finance the car over 6 years, and offers to do so at $702/month. Is that a good deal? In order to decide you need to be able to calculate some numbers, and have some external information. One piece of information you need is "what interest rate would someone charge me to borrow $35,600 and repay the loan over six years?"

In this case, the answer depends on whether you can get someone else to write this loan for less than 12.3%. All in all, these are not difficult calculations (and any number of web-sites, calculators, or spreadsheets will perform them for you).

However ... when you are negotiating procurement or outsourcing contracts don't assume all the parties at the table will be able to perform these calculations - especially "right there at the table" and that even if they can, that they will think the result is reasonable.

I'm often surprised at how frequently clients (and sales staffs) get tied up on this issue when services are paid on a deferred basis. You will often see sales staff asking for outrageously high margins just as often as you'll find a client wondering why they can't pay, for example, $1M in 10 years for $1M in services today.

And just when you think everyone is on the same page and being all reasonable, then we need to consider deal and partner specific risk ...

Cheers,

David Rotor

A quick hello and and some fast procurement news

2007-06-13T11:16:00.000-05:00

I've been off working on a confidential client project so I have not been able to post anything recently. But I thought some of you might find this juxtaposition of two of my favourite topics interesting.

The rising cost of carbonfibre

"The current worldwide shortage of carbonfibre is going to make it more difficult and more expensive to build racing cars, until supply catches up with demand."

Click on the link for the full story from www.grandprix.com

Yet another supply risk post

2007-03-03T11:28:00.000-05:00

The usual suspects of smart supply guys ...

Michael (Sourcing Innovation) - here - here - here (and many more)
Tim (Supply Excellence) - here - here - here (and also many more)
Jason (Spend Matters) - here - here - here (and you guessed it ... many more)

... keep trying to make us pay attention to supply risk. A recent quote from Michael "Your supply chain will be disrupted. Bet on it. You'll win." If only some of the brain trust in the Toronto and Calgary offices of Imperial Oil (Esso) had been paying attention. While it's been making news for a week or so, (and hitting our wallets) today's Globe and Mail article on the retail gasoline supply chain disruption in Ontario provides a nice summary of how it happened.

1. Take a couple of refinery fires to constrain production.
2. Add in the winter closing of the St. Lawrence Seaway (if you're not familar with the seaway, or perhaps more importantly if you think you do, spend some time on their site to gain an appreciation of just how important this stretch of water is to the North American economy) to limit alternative distribution
3. Simmer with a rail strike to further limit distribution

The result has been a 25% spike in retail prices for gasoline and "dozens" of gas stations being closed due to lack of gasoline. If this can happen in Ontario in a widely competitive commodity market like retail gasoline what are the odds that it can happen in your supply chain? If you disagree would you care to take me up on Michael's bet? Thought not.

Cheers,

David Rotor

A life without compliance

2007-03-02T13:31:00.000-05:00

Ask procurement types what are their major challenges and you'll routinely hear:

1. Talent (attracting, training, and retaining);
2. Data visibility; and
3. Compliance

Let me touch on compliance today. I've worked on a variety of models to drive compliance both on the demand side (buyers using the right mix of contract, supplier, and scope of service or specification) and on the supply side (suppliers honouring their commitments). My current approach has been to treat this as a sales/marketing challenge (here and here). What if we're all wrong?

Russell Roberts, writing in Cafe Hayek, talks about "Order emerges in unexpected places". His example is the experience of a couple of European towns that are deregulating their traffic patterns by removing signs, traffic signals, and the like. I'd say it was counter-intuitive, but I guess most of us actually would guess that, indeed, accidents are reduced with fewer controls. I seem to recall reading someone (The Economist, Marginal Revolution?) on this topic not long ago, and if I recall correctly it was posited that fewer external controls meant individuals felt an obligation to have more responsibility.

Can this approach translate to the procurement world, and if so, what should procurement departments consider to make it effective? It's not so crazy, most companies have some form of procurement anarchy already:

1. Expense policies that allow travellers to select hotels and restaurants
2. R&D labs that are exempt from production procurement rules
3. Conference planning that is not restricted by corporate travel regulations
4. Gifts and trinkets
5. Media and advertising relationships

etc, etc

To make it effective I believe that three conditions are necessary:

1. The cost of the decision must be visible to the person making the decision. This is often referred to, in the negative, as "visual guilt". If you can display lower cost options, the decider will often select the lower cost. A real world example is what the folks at Rearden Commerce are doing for travellers.

2. The decision has limited impact on business processes beyond the control of the decision maker. This is really just expanding on the first condition, purchases that entail risk, long-term maintenance or support costs, or which impact other purchasing decisions probably should not be left uncontrolled.

3. Decision that are either very simple and quick to make (I'd like that pen, not that one) or extremely complex and ad-hoc (this charting software is better for my development team than that one). Simple, as the cost of involving a procurement administration to make the decision would often out weigh the cost of the purchase. Extremely complex ad hoc decisions because those decisions are very difficult for the procurement department to have expertise and add value, and if they are truly ad hoc their is little value to be gained from the experience that will translate to other buying decisions.

Any thoughts, other than to lynch the procurement heretic?

Cheers,

David Rotor

Shared savings?

2007-03-01T09:17:00.000-05:00

I'm working on a few investment opportunities that have come up for this fund. The fund is, obviously, interested in the mechanism for shared savings and while we are starting with a bias on how the funds would flow it's been useful to work through some other scenarios.

We're exploring five shared savings models:

Identified Savings
Front End Rebates
Back End Rebates
Transaction Payments
Periodic Payments

Identified Savings
This is commonly used by strategic sourcing consultancies that have contingent savings contracts with their clients. Savings are "identified" but not realized prior to payment. Often the milestone for payment is at the time of awarding a contract to a supplier that provides lower costs for a good or service.

Front-end Rebate
In this model the supplier takes on the future purchased volume risk in a contract and pays the client their savings at time of contract award.

Back-end or Volume Rebate
In this model the supplier pays the rebate at some pre-determined point in time, such as quarterly, annually, or at contract expiration. This is normally defined either as a lump-sum payment (thereby having the supplier hold the purchased volume risk) or as a volume related payment (thereby having the client hold the purchased volume risk.

Periodic Payments
Savings are tracked and paid on a periodic basis (often monthly or quarterly). While there can be multiple mechanisms this form of shared savings are managed they are usually based on tracking the volume of purchases over the defined period and applying a savings formula to that volume.

Transaction Payments
Savings are tracked and included in the transaction. Payments are made coincidental with supplier payments for each relevant transaction.

Sit down and read this

2007-03-01T09:05:00.000-05:00

Procurement "professionals" are often asked, either seriously or in jest, for retail buying help from friends and family. While there is obviously some overlap in skills and approach, it's a bit akin to asking your friend the Finance Director for help selecting a life insurance policy. Over at the consumerist, they've posted an article aimed at the consumer buyer, that has a lot a valid points for the professionals. The topic is buying on-line furniture, but just as it makes sense for a professional, it also makes sense for categories beyone furniture. Here are a few of the tips, and a link to the full article.

#7. Ask them about the shipping procedure and how long it takes for
the order to be processed.
# 12. Confirm everything. Hold them to their word, and WRITE DOWN THEIR
NAMES. Get their last name if possible.
#6. Ask them what the furniture is made of, and if it can be configured in
a number of different ways.
# 3. If they have a warehouse, ask for a tour. Take a look at the way they
warehouse employees act and handle the packages. What the retailer expects of
its employees is what they expect from their manufacturers.

Cheers,

David Rotor

Elevated pricing - supplier cooperation gone bad

2007-02-22T09:47:00.000-05:00

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

2007-02-22T09:34:00.000-05:00

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

2007-02-20T10:19:00.000-05:00

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

2007-02-16T11:06:00.000-05:00

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?

2007-02-12T11:04:00.000-05:00

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

2007-02-07T16:49:00.000-05:00

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.

2007-02-05T14:21:00.000-05:00

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

Brrr.

2007-01-30T10:13:00.000-05:00

Not being quite sufficiently frozen to the bone with -20c (-4 for those brave souls still stuck on Farenheit) at home, I'm heading off to the Winterpeg to experience -25c (-13F) for a couple of days. Feel free to keep the fires burning for me in here.

Cheers,

David

Making pretty

2007-01-29T12:09:00.000-05:00

I've updated the look, and some of the content, on the Procurement Investor home page.

Here's the new look:

And the old look:

Still fighting the talent war

2007-01-24T17:48:00.000-05:00

(No I don't know anything about this comic - but it has great cover art for this article on the talent war)

The topic of recruiting and retaining procurement “talent” is a perennial favourite. Here are a bunch of articles:

Here - European Leader Net

Here - European Leader Net
Here - Procurement Central

Here - Supply Excellence

Here - A comment on Jason Corsello's blog, which is comprised of links to articles on procurement talent!

and

Here - Shared Services BPO

It was top of mind during a discussion this week about estimating strategic sourcing savings. In short, for the situation under discussion, we had two options to consider. The first was to provide training and technology support to a group of corporate buyers. The second was to engage “world-class” consultants to do the strategic sourcing for the client. Should we estimate a difference in savings between the two options? The consensus answer was that we should expect higher savings if we use the consultants. If you accept that the world-class consultants are more “talented” than a group of corporate buyers it appears that we were betting on talent.

In my case, that’s not true. I was betting on market knowledge.

A quick digression. I use the concept of “Market Power” to indicate the ability to negotiate favourable supplier contracts. The more market power you have the better the deal you can negotiate. Several things can contribute to increasing your market power. In my experience the most powerful are:

* Purchasing Volume - the most common approach (not the best, merely the most common) to strategic sourcing is to aggregate as much of the company’s spend as possible into a single contract
* Compliance – the ability to shift demand within your company to your preferred suppliers (and to credibly communicate this ability to your suppliers)
* Market Knowledge – the amount of information you have on current market conditions and suppliers

As I discussed, here, many organizations both over-estimate the degree to which volume will drive better prices and also often fail to understand what are the price/volume economics for a particular good or service.

Your suppliers' view of your compliance management ability (not your internal view) will strongly impact your market power.

In my experience, market knowledge is the strongest contributor to market power. Knowing what others have recently paid for a good or service, what the production capacity or utilization rates (goods, services) a supplier and their industry are experiencing and can support, what T&C’s impose non-standard costs on a supplier, etc, do more to allow great contractual terms to be negotiated than simply adding and delivering volume to a supplier.

Back to the discussion on relative savings rates. I was betting that the consultants would have more market knowledge by the simple matter of their firm frequently going to market for their clients as opposed to the corporate buyers who generally would only go to market every few years.

It would be fashionable, often true, and egalitarian to also say that consultants are rarely more talented than corporate employees. I don’t believe that, I think good consultancies often have very talented people on staff. What I do believe is that reasonably competent people who are provided with the right tools to build market power will out-perform highly talented people without those tools.

This raises some interesting conclusions. First, if you're going to bring in sourcing consultants, make sure the ones who show up have access to their firms recent market experience, and don't assume just because they are from a well-known sourcing consultancy that that is true.

Second, if you are fighting the “talent wars” you must also consider the environment in which that talent will be deployed. Can you offer talent an environment where they can promise and deliver on compliance commitments to suppliers? Can you provide them with the information they will need to remain market knowledgeable?

If the answer to either of those questions is “no”, “maybe”, or “we hope the talent will bring that to us”, you maybe showing up to a gun fight with a knife – talent will migrate to where they can be successful and remain talented.

Cheers,

David Rotor

Wiki'd out

2007-01-22T17:03:00.000-05:00

Earlier I posted that I had migrated to www.procurementinvestor.com and that I had some small ambitions for the new site. I was able to figure out how to get one piece working this week. The Procurement Investor Wiki is up and running.

A wiki is a website that allows collaborative editing of content. The Procurement Investor wiki focuses on procurement topics, and encourages readers to help to develop the content on these pages for our mutual use and benefit. The wiki is grouped into topics. The first topic is:

The Category Hierarchy - Defining a hierarchy of goods and services that are logical for procurement.

As it develops I'd like to add a topic on supplier pricing, supplier quality, and sample bid documents. As those sections develop I'll announce them in here.

Cheers,

David Rotor

$1B a day in cross-border shopping

2007-01-19T10:05:00.000-05:00

This is the time of year that Fleet managers are thinking about their final purchases of the 2007 model year. They’ll continue to be paying a huge premium if they are on the northern side of the Canada-US border (except, of course, the funny inversion you get with Detroit being north of Windsor). Last summer Canadian Driver, published this article, suggesting that prices in Canada, normalized for such things as exchange rates and trim levels, are 17% higher for the same vehicle. As with any study like this the actual amount varied dramatically by vehicle, here’s a chart produced for their article, the source is credited on the image, but I can’t quite make it out.

The article normalized for currency exchange between January-July 2006. Here’s a look at the monthly average exchange rates between 1999 and 2006, from the Bank of Canada (and their currency exchange page).

This price differential across the Canada-US border is going to vary by category of good or service, but cross border economic activity is above $1B per day. If you’re not benefiting from exchange rate/price arbitrage, odds are good that your supplier is benefiting. As always, market knowledge can go a long way to evening the odds, so don't just look locally for price benchmarks; your suppliers view their markets globally, so should you.

Cheers,

David Rotor

Fuel surcharges, part deux

2007-01-17T21:17:00.000-05:00

Tim Minahan, is picking up on the fuel surcharge issue. Thanks Tim.

Limits of Sourcing?

2007-01-17T20:56:00.000-05:00

I've had a busy week. Apart from moving to a personally owned server, Procurement Investor, I've also been working on a large procurement outsourcing deal, the same one I wrote about here. And, I've been taking a look at some leads that are coming in from my post on looking to invest in procurement savings. I talked with some folks at Ariba on Monday, sharing some thoughts on delivering savings for our clients.

But the thing that's really caught my attention this week has been "how small is too small?". I've had the chance to look at some small companies this week, one that had only $5M in payables. It's not unusual to find a sourcing person who will claim that they routinely save 10+% on purchasing. We all, and I'll include myself here, always talk about how big a spend we've saved against. No one brags about how small a spend their expertise is effective against.

I'm intriqued, can strategic sourcing work for a $100M revenue company? How about a $10M revenue company?

If I find out, I'll let you know.

Cheers,

David Rotor

New foundation, same face

2007-01-15T14:22:00.000-05:00

Over the weekend I "moved" to a new site Procurement Investor but through the magic of google nothing else has changed ... yet.

Oh and my email addy in here has changed as well. davidrotor "at" procurementinvestor.com

I plan a few enhancements for the site which necessitated having more than just blog space. If I can work it out, the first thing will be a wiki style category hierarchy. I currently use a three-tier approach for indirect of:

Family
Group
Category

Here's a picture of the first two levels. I'll announce in here once I figure out how to make it into a wiki.

Looking at data, big picture and little picture

2007-01-11T13:32:00.000-05:00

I posted my thoughts on the future of expenditure analysis, moving from historical to real-time analysis and intervention into a transaction. But I also said I respect the typical data mining approach. Here’s an example of data mining that can really help to bring understanding to your clients, executives running other business units. Hat tip to David Bush, at E-sourcing forum, yesterday he led me to an article on micro and macro expenditure analysis from November on his site. Well worth reading for anyone thinking about how to understand buying patterns.

The article reminded me of a clever chart a team looking at PC spend put together to help client executives understand the strategy they were proposing. They had gathered data from about 50 departments, which let us understand a high level view of purchasing patterns.

(All data presented has been changed and “anonymized”)

I like to start to understand expenditure using a “macro” approach I call “5X4” reporting. 5 axis of data reported against each other:

1. Category of Spend
2. Supplier
3. General Ledger (GL) Code
4. Business Unit
5. Geographic Location

Here are two generic examples of 5X4 reports, the first has Category as the pivot and the second shows Supplier as the pivot. The others follow the same pattern, and you can sort the charts alphabetically, by $ amount, etc.

5X4 Category Spend

5X4 Supplier Spend

The quality of data will vary be organization and axis. I often find Geographic Location and Business Unit data are pretty sketchy.

When we looked at 5X4 data for PC spend we made some observations:

1. It was a big category of spend, tens of millions for PC’s alone
2. Spend was well consolidated to a handful of major suppliers.
3. There were noticeable differences in the macro benchmarks; Spend per employee, Square footage, and % of SG&A costs varied by department in ways that we couldn’t understand based on the type of work performed by those departments
4. There was the usual mis-coding of GL spend.

Nothing that jumped out at us to say we should make this a high priority category for sourcing.

Next we looked at the data (hundreds of thousands of lines of transaction data) using a standard stock chart from excel, “Volume:High:Low:Close”.
By department expenditure data these adjustments were made to the input definitions:

Volume = Total dollars spent
High = the highest price paid for a single PC
Low = the lowest price for a single PC
Close = the mean price for all PC’s purchased.

Here are a few of the questions we expected the chart would lead us to investigate:

1. Are large variances in low to high price due to a wide range in quality and specifications being purchased or a wide range in price being paid for the same quality and specification?
2. Does the departmental pricing look similar for departments with similar work and labour forces?
3. Is the volume of purchasing for similar departments also similar?
4. Would we see variances in the lowest and highest prices across departments? A large variance in the high price would be easier to understand than a large variance in the low price.

And some other observations we expected to make:

1. The lower the mean price was to the low price, the more units were being purchased at the low end of the price scale
2. A mean price in the middle of the price range indicated just as many high price units being purchased as low price units

Again, with the data changed, here what the chart looks like: The chart led us to look for answers in the full set of transaction data:

1. We found the wide price variance at “A” was equally due to a same unit price variances and to a wide variety of specifications being purchased. Given the size of the spend and what we also knew about the department, we were confident that PC buying was basically a “Free-for-all”.
2. Departments “B” and “C” were virtual clones. Same city, same type of work, same type of labour force. We expected similar purchasing behaviour and this data confirmed it. By cross-checking the macro data (5X4)’s though we observed that price per employee was more varied than we expected. It turned out that “B” generally kept PC in service for 4 years, and “C” for five years.
3. “D”, “E”, and “F” were a surprise. Again, pretty much clone departments with pretty different purchasing behaviours.
4. “I” was a revelation to the executive who ran the department, he had been in charge for over 10 years, ran an “analytical” department and confidently told us he had standardized PC purchases and had tight internal controls “best in the business”. One look at his chart and he immediately understood the data had proved otherwise. He was a good enough executive that he accepted and appreciated the data.

This analysis and the discussions that ensued with the business units were then directed into crafting a market strategy for purchasing PCs across the organization.

Cheers,

David Rotor

And ... Action!

2007-01-10T10:41:00.000-05:00

The E-Sourcing Forum has a couple of interesting posts this week. This one discusses expenditure analysis, reviewing an article in European Leader in Procurement. Here’s a quote from E-Sourcing.

“As the author explains, the future of spend intelligence lies in dealing with historic data and system issues by enriching source data and providing flexible on-demand reporting for all aspects of P2P.”

I agree in the value of expenditure analysis, in 2006 I led a team that needed to understand $20 billion in purchasing across over 100 organizations. It will come as no surprise to anyone in procurement that among the very first things we did was start grabbing data to build an expenditure database, and then started mining that database to understand both micro and macro purchasing behaviours.

So when I say I don’t entirely agree with author that the future lies in historic data, it is with respect for the thought process and outcomes he is driving towards. My belief is that the future of spend intelligence, and really in the procurement function is to move from a passive role to that of an active participant in procurement transactions.

Much has been and will continue to be written about the sometimes desire and sometimes success of the procurement function to move from being a transaction processing function to being a strategic business partner. What that means to me is that procurement needs to take an active role in deciding when and how a firm spends money and other resources. Procurement teams can and should be able to contribute to corporate risk management discussions, not simply supply risk mitigation. Procurement needs to view their function as a market, and execute strategies and plans to capture larger and more “profitable” market shares.

When one then considers the future of expenditure analysis, we should start by understanding that there are pretty decent tools, processes, and technologies to enable us to do very good analysis of historic data, and to create flexible on-demand reporting. This type of analysis is great and it supports, but doesn’t replace “strategic procurement”.

What I want is the ability to do it right now, in real time. Procurement should have the ability capture, analyse, and impact each purchasing transaction as it is happening. Notice I changed language, procurement to purchasing. I’m using procurement to signify the “strategic” role and purchasing to denote the transactional role. Here’s the thing, as “Procurement” or “Supply Management”, becomes successful in evolving to a strategic business rather than an operational support role, it can’t forget the transactional purchasing role. There are two main reasons not to forget that role. First, and most obvious, is that much of the rest of the business expects it. If we can’t do our job, then forget about playing in the big leagues.

Second, it’s where “power” lies. Procurement function performs some of our more strategic functions based on analysis; moving volume, substituting products, aggregating deliveries, eliminating redundant payments (duplicative insurance for example), constraining or shaping demand, updating specifications, lowering supplier input costs, and so on. Now do it in real time. Some businesses can accept that procurement needs a fiscal quarter to understand what happened. Many businesses need procurement to help guide what’s happening today, to ensure next quarter’s fiscal results meet expectations.

To me, that’s the future of expenditure analysis.

Cheers,

David Rotor

Surcharges or overcharges?

2007-01-09T17:47:00.000-05:00

Update 2: Air Canada is feeling defensive about surcharges. The thing that doesn't ring true to me is that because the airline is hedging fuel prices (and their hedge price is now higher than market price) they want to maintain a higher fuel surcharge. So, I guess when their hedge price is lower than the market, they won't increase the surcharge and cite the rising market price as justification. Right

.

This week's Economist has a report on the falling price of oil. Oil has declined from a high of just over $75 in the summer to just over $55 this week. Call it a 25% decline in 6 months. This might be a good time to have a hard look at any fuel surcharges built into your supplier contracts. You'll find suppliers of parcel and overnight express, travel providers, 3PL (third party logistics) often have contractual rights to add fuel surcharges to your negotiated prices. Less obvious will be suppliers of other goods that add fuel surcharges to their freight/delivery charges, depending on how those are negotiated. Having had a look in recent weeks at some corporate invoices, those surcharges don't seem to be declining as quickly as they rose.

Cheers,

David Rotor

Update 1: It seems that Michael O'Leary, CEO of Ireland's Ryanair agrees with me. Quoted today saying. "There is a fuel surcharge scam going on all over Europe. These aren't discretionary, you can't avoid them. They all said they would review them as oil prices fall. We said it would be a cold day in hell by the time they'd be reducing these fuel surcharges. We've been proven correct."

Searching for a deal

2007-01-04T11:38:00.000-05:00

The Canadian press is full of stories this week about Canada's decision to purchase new search and rescue aircraft (SAR). Here's a representative column. In short the issue is whether the decision should be made by using a competitive bid process or whether the government should make the decision without using a bid process. Few commentators are unbiased on this one, politicians are weighing in based on partisan belief. Liberals and the NDP are shouting abuse of power. Conservatives are stating that they are supporting the brave men and women in uniform. Lobbyists, depending on who they lobby for are saying 1) what a great decision!, 2) outrage!, or 3) Canada should buy in Canada!

I'm biased as well, my bias is that the procurement process should be designed to deliver best value, and then that process should be respected. I've previously written that the bid process is often flawed, imposing time and cost that often is not rewarded with better value. Canada is not a major player in defence procurement - as one writer said in response to an article in the Globe and Mail, there were three times as many SAR aircraft sitting outside his window at a base in Washington as Canada was buying for the entire country. The procurement process I found that usually delivered the best value was to piggy-back on larger orders from our allies.

The best known program is the US' Foreign Military Sales program, but our other allies including the UK and Australia run similar programs (as should Canada). This procurement process meets the public policy objectives of open bidding, though the bidding is run by an ally not by a Canadian. The real value is that it dramatically speeds up the procurement process, lowers the adminstrative cost of the program (which can add 30% or more to the real cost of a procurement), and normally delivers the equipment sooner and at a lower cost.

So why is the program so little used? I suspect its because it would make the military sales lobby groups ineffective, reduce the role of politics in procurement decision, and it would also eliminate large numbers of miltary (though desk-bound military) and public service jobs.

Cheers,

David Rotor

Back to business

2007-01-02T15:41:00.000-05:00

This past fall I’ve been working to raise a fund to directly invest in improving procurement operations for companies. Over the winter holidays I was informed that the fund will be closing in two tranches, mid-January and March.

The fund is authorized to make investments that will generate financial savings for client companies. My “tag line” for this blog is that “There are few investments a company can make that rival the returns from investing in their own supply chain.” The expected returns from this fund are representative of that thinking. We expect to invest $2-$3 million with a goal of generating $20-$30 million in savings from expenditures of $200-$300 million. Here's a two-page summary of the offer.

Investments from this fund will primarily be used to pay for consulting fees for strategic sourcing – we intend to hire world-class sourcing firms to do the sourcing on these engagements. In order to deploy the funds we’re looking for client companies who are want a risk-free way to lower their cost of purchased goods and services. As this fund progresses I’ll provide, on a “no-names” basis, details of some of the company opportunities we look at, and any investments and savings we make.

And the shameless sales pitch … you can contact me through my blog email, davidrotor@procurementinvestor.com if you know of any companies that might be interested.

Cheers,

David Rotor

Tagged

2007-01-02T15:04:00.000-05:00

Wendy has tagged me. I'm meant to:

1. Find the nearest book.
2. Name the book & the author.
3. Turn to page 123.
4. Go to the fifth sentence on the page. Copy out the next three sentences and post to your blog.
5. Tag three more folks.

I'm already off to a bad start with nearest book. I've got a couple of stacks on the desk, I'll take the top one on the pile to the right. Neal Stephenson's The System of the World. Daniel Waterhouse, has recently returned to London and has begun certain investigations.

That brought him clear of Hockley, and into the center of the largest open place in this part of town, where Leather Lane, Liquor Pond Street, and several other ways came together in a crazed, nameless interchange half the size of Charing Cross. There, finally, he turned around. "Your watch, sir, said a bloke, "or so I surmise."

I'll pass on #5 ... It's funny, I don't in any way mind Wendy tagging me, but I feel uncomfortable at doing so to others.

Happy Holiday, see you in 2007

2006-12-22T10:21:00.000-05:00

I'm going to take next week off for time with friends and family. See you in 2007. And as a little holiday treat. Here's a link , from Tim Minahan, to the value of sourcing. It seems that e-sourcing will save you 80% on the cost of the 12 days of Xmas.

Cheers,

David Rotor

Engaging internal clients

2006-12-20T17:29:00.000-05:00

In Buying Market Share I touched on the idea of measuring procurement department effectiveness through the share a category manager has earned (compliance) of the internal market to purchase their good or service as well as the share of an internal client's overall spend that the procurement department has earned. To improve, the procurement department needs to better meet the needs of its market. The simplest way to do this is to understand the market, whether it is for a single category across the organization, or the multi-category spend of an internal business unit.

I created an approach, Client Engagement, ~~stolen from~~ borrowing on skills and techniques from the sales world that allows the procurement team to engage with their clients in order to better understand their requirements and drive improved market share. For readers with experience in strategic sourcing, this level of engaging with a client is similar to what is done during a category sourcing exercise, but moves from being a event driven exercise to embedding it as a recurring procurement department business process. Here’s a graphic that provides a summary of the Client Engagement process.

Buying market share

2006-12-18T13:25:00.000-05:00

There are a few topics that routinely get discussed in the procurement world. Later today I'll be talking with some ex-colleagues about a situation where their client wants a deeper understanding of how success will be measured in an outsourced procurement environment. Tim Minahan, at The Aberdeen Group, was thinking about this topic recently as well. Tim is an old hand at procurement services, and is one of the more reliable commentators for this sector. Here's a comment I left in response to his KPI post.

Hi Tim,

I agree with your comment:

“No single metric defines supply management success. (Although, I personally believe that spend under management, as defined above, comes pretty darn close.)”

I’ve been using “spend under management” as the leading indicator (metric) for indirect procurement department effectiveness for several years now. I’ve found it effective across several industries, and even in the public sector. I also often refer to it as our department’s “market share” as executives in other business units understand the language, and often intuitively accept that market share growth is “good”.

I measure procurement market share against two axis. First, from a category manager’s perspective, what’s the corporate-wide compliance with each of our category offerings. For example, “the compliance rate for our preferred cell phone carrier was 89% last quarter”. The second axis is from a customer perspective; what’s our market share for a given client department. For example, “our market share of the COO’s spend is 92%”.

The value of this approach is it provides feedback to allow the procurement department to understand what the rest of the organization values, and what it does not. It also enables discussions around client requirements “why is our market share so low on the east coast?”

Cheers,

David Rotor

Bending over backwards when you're buying

2006-12-14T12:15:00.000-05:00

When you're trying to create a strategy to lower the category cost of a good or service within for a company it's practically a given that among the first things that is done is to attempt to aggregate demand for a particular good or service. There is the usual tussle between centralizing control and delegating authority out to regions or business units. It's probably no surprise that I tend to come down on the central control side of the argument when it comes to procurement, but what may surprise some is that I attribute less of the value to centralization to aggregated volume than I do to access to information. Experience has proven to me that buyers armed with lots of recent market knowledge routinely will negotiate better deals than buyers armed only with bigger volumes. This post will try to provide a partial justification for that opinion, and it's based on a couple of special cases of supply and demand curves from our friends in economics, the backward bending supply curve and the u-shaped cost curves. I've used material from Wikipedia to help illustrate my points.

Standard supply and demand theory tries to explain how the amount of demand for a good or service and the amount of supply of that good or service interact. In relation to the amount of supply, the more demand there is for something, the higher the market price. The more supply there is in relation to the demand the lower the market price. Here's an illustration from the wikipedia entry.

This is the primary reason why buyers like to aggregate their demand - assuming adequacy of supply the more you buy (the red downward sloping line) the lower your per unit costs should be. Of course, in the real world sales teams don't pay much attention demand curves and will happily charge companies with larger volumes higher prices.

The backward bending demand curve is often used to describe labour markets "As a person's wage increases, they are willing to supply a greater number of hours working, but when the wage reaches an extremely high amount (say a wage of $4,000 per hour), the amount of labor supplied actually decreases". I can't recall ever seeing this behaviour in the market, or at least that couldn't more accurately be described as simply lowering supply and increasing price. It is worth having buyers understand, if only to help them understand that the standard curves don't always apply.

The u shaped cost curve, where the cost of a good or service initially decreases with volume and then begins to increase with additional volume is pretty common in real markets. There are many reasons, the main reason why companies accept a supplier having a u shaped cost curve is that the increased price they pay to a supplier that has a higher cost with more volume is often lower than the company would incur for introducing a new supplier "switching costs". The u shaped cost curve looks like this (don't blame wikipedia for this one).

I've run into this curve several times, usually while negotiating corporate-wide, or nation-wide deals for companies. Here are a few examples:

Waste removal for a US based national housing REIT
Travel agency and card services for a global telecommunication firm
PCs for a national Canadian bank
Office supplies for a national government
Airline travel for a global media company
Facility Management services for a commercial property REIT
MRO and parts for a military
Engineering supplies for a continental freight railway
Food and snacks for a global media company
Consulting services for a national government
Packaging supplies for a global manufacturer
Consumer shopping bags for a national retailer
Recycling services for a brand-name retailer

And the list could continue. The list of examples is deliberately diverse both in industry served and in category purchased. There are, at least, three similarities. First, in every case the organization was large and geographically dispersed, the second is that the good or service being purchased was not being consumed by a manufacturing process (in other words they are "indirect" goods and services). The final is that none of them are classic "commodities", there are no public traded financial instruments to buy and sell waste removal service "futures".

With time, expertise, and the ability to test the market frequently, buyers can get a reasonable level of understanding of when a price curve for a good or service will begin to curve upwards. Often it is a function of both volume and geographic dispersion. It might cost a supplier more to service one city than another depending on how much business they have in each location. You might find that a supplier has production capacity constraints that you are bumping up against.

You want your buyers to lower the total cost of a category of good or service. They should consciously be aggregating and disaggregating volume to find the optimal "demand" offer to the market. That often means letting them pay a premium for a given geography or range of goods and services if that means an aggregate lower cost overall.

Cheers,
David Rotor

Shipping Costs - not quite a Marginal Revolution

2006-12-12T13:57:00.000-05:00

Tyler Cowen over at Marginal Revolution, posted a suggestion to read this article at the New York Times. The author, Meline Toumani, makes the point that sea containers, the "giant metal boxes" have had a dramatic impact on the viability of trading goods internationally. One point I disagree with is her quote - The process is so efficient that transport costs have become "little more than a footnote in a company’s cost analysis" from author Mark Levinson's book “The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger”. She goes on to attribute Macy's decision to source clothes in Malaysia rather than down the block largely to a reduction in shipping costs. Having done strategic sourcing work for Macy's and its sister firms in the Federated Department Stores family, I can't quite agree. Labour rate arbitrage has, to my mind, more to do with the cost advantage Malaysia has over the garment district.

Let's take a look at Levinson's comment. PricewaterhouseCoopers,(1) published "Cutting your distribution cost" in 2004. Here's a chart from the report, that shows that distribution costs remain substantially more than a footnote:

The data, which seems pretty representative from the companies I've looked at, shows that transportations costs ranged from 0.27% to 12.57% with a median of 2.15% expressed as a percentage of revenue. I can tell you that Macy's isn't at the low end of the range, and few companies would consider even 27 basis points of their revenue as a footnote.

In another client situation, a hospital organization in the US North East. They spent about $750M annually, with just under $4M of that going for freight and logistics. When we took a look at the $4M in spend, they had over 2,000 suppliers providing transportation services. Savings in this one category were on the order of $500K. While, perhaps, not the most important spend category for every firm, I'd take a hard look at them when you're trying to reduce your costs for goods and services.

Cheers,

David Rotor

(1) - Under "full disclosure", I previously worked for PricewaterhouseCoopers, as a Vice President of Global Sourcing.

Food bank economics

2006-12-11T10:02:00.000-05:00

I listened to a "feel good" news story this morning on CBC where the station was congratulating itself on raising funds for a local food bank. The bit that really caught my attention was that the food bank is better off with cash donations than food item donations; they have negotiated wholesale prices from food distributors.

Good for them, a local non-profit community service organzation is using their market power to lower their operating costs, and improve the volume of goods they can deliver to their clientele. It left me wondering though; here's my line of thought.

First, as I understand it, food banks mostly serve "working poor", people with jobs or who are on some form of fixed income, who are not earning enough to meet their basic needs. Second, there is usually some form of rationing, such as one food hamper per family per week. Assuming for a moment these two assumptions are true, I wonder whether the food banks can extend their discounted prices to their clients? Their clients are presumably paying for some of their own food, at retail pricing, only getting a partial subsidy from their periodic free hampers. By extending the preferential pricing to their clients they would be able to further their organization's goals, and may in fact, also add to their market power, increasing their ability to negotiate preferential pricing for food.

Outsourcing business cases

2006-12-08T09:31:00.000-05:00

I'm spending some time thinking through an outsourcing business case. The client has an expectation that the proposal will fit into their existing budget for the function (procurement and payables), independent legacy systems will be retired and new functionality will be added with the introduction of an integrated system, and ideally costs will be lowered. On the other side the service provider understandably wants to do all that, and turn a reasonable profit. So far, so good.
The difficulty is that the service provider's business case is turning up at about 150% of the existing budget. The work can be pretty quickly broken down into three areas to explore, plus one more:

The existing budget

This is a classic outsourcing issue, service provider's routinely strive to identify expand what's included in the existing budget, and client's routinely try to limit what's included. Direct costs are reasonably straight forward to nail down, allocated indirect costs such as contributions for space, corporate technology, support functions such as HR and accounting, are the usual areas that cause conflicts, and can determine whether a deal proceeds or fails.

The service provider's cost model

This tends to be a great area for "pursuit teams" (sales) to delve into in great depth. Most large outsourcing service providers have built wonderfully complex cost models to help them capture what it will cost to service an account. Routinely, I'll find that there is a bit of a fortress mentally around the cost model and it can often be as difficult to get the team to disclose line item details from the cost model as it is to get the client to share detailed budget information.

The first area to explore is whether the costs are market based or internally derived - don't accept the assertion from the cost team that they are market based, go and test the market yourself.

The second area to test is whether the internal costs have been inflated with an internal mark-up, again the cost team will routinely suggest they do not mark up costs, prove it for yourself.

The third area to examine are the overheads, are there too many people loaded onto the deal, are there costs loaded such as standard space or technology charges for people that have already had those costs modelled as direct costs for the contract, etc.

Going back over the last decade I've seen numerous cases where the cost team has contributed to proposals being, literally hundreds of millions of dollars over the market.

The service provider's pricing model

There is often little a pursuit team can do about the margin the company wants to earn from a contract, you win or lose in the market and margins will be adjusted to reflect that reality. What the pursuit team can do is vigorously target the "risk" model that can increase or decrease the margin calculation. Most (likely all) the major outsourcing service providers have developed formal risk management frameworks in their internal deal approval process. The one for the deal I'm looking at now runs about 200 questions, such as: Is the proposed deal a "factory" deal or a "fortress" deal? “Factory” means that it can be managed in a shared service facility, “fortress” means it is a unique offering that is customized for the client. Fortress deals have, in the model, a higher risk factor, and the discount rate applied to the price model is increased. Each of the 200 or so questions have similar impact on the discount rate. The pursuit teams need to spend time understanding the risk model, but often it is viewed as an administrative exercise, and the pursuit team doesn't ever really understand how the model will impact the success or failure of their proposal.

Strategic Sourcing

Outsourcing teams should also consider lowering the cost of goods and services in the function they are taking over by using strategic sourcing. I won't get into it in this post, but it's often possible to lower those costs by 10% or more, enough that many deals will live or die on the application of sourcing to the deal. Spending time to have an expenditure analysis performed to determine if there is an opportunity is well worth considering.

Cheers,

David Rotor

Phil Nimmons speaks

2006-12-07T09:18:00.000-05:00

Another quick post that has little to do with procurement. As I mentioned on Tuesday, I was in Toronto for a couple of meetings and to attend a concert at the CBC's Glen Gould Theatre by the Dave McMurdo Jazz Orchestra. The concert was recorded, and will air February 25, 2006 on CBC's "OnStage". The feature of the evening was the Canadian premiere of Phil Nimmon's "Conversations (Aural Communication)", a piece Phil wrote last year as the inaugral "SOCAN/IAJE Phil Nimmons Established Composer Award". Conversations is classic Nimmons, it's all instrumental and showcases several of the great soloists in Dave's band. It's not the most accessible style of Jazz, without a vocalist to guide the audience instrumental jazz tends to require active attention.

Throughout the piece I could hear Phil's desire to have the piece represent the musicans and their instruments talk to each other. I found it was like a really successful party where there are a bunch of interesting people chatting to each other with sometimes one and sometimes several conversation threads happening at once. One of the highlight soloist bits was Alex Dean on sax doing a bit of "free-blowing". I don't know if it was intentional but it sure seemed to be a homage to the way Phil is best known for playing, just this side of out of control, arms, legs, and body practically bouncing off the stage. Elaine and I and a few friends thoroughly enjoyed seeing the band live again, getting 20 people on stage playing live jazz doesn't happen very often in Canada.

Auditory consumption

2006-12-05T09:14:00.000-05:00

Short post today - I'm off to Toronto for a concert and will squeeze a couple of business meetings in too.

Dell in the news

2006-12-04T10:46:00.000-05:00

The Economist has an article, Commoditize This, about Dell. In summary, it points out that Dell faces some challenges, it has lost its market leader status in PCs to HP, there are some regulatory investigations going on, and its market focus, direct sales to businesses, is growing slower than HP's retail to consumer business. Michael Dell is placing a bet on growing his services business, but the Economist rightly points out that the growth of IT service businesses in India may make that move less profitable than Dell would like. I used to be a big supporter of Dell when acquiring a "fleet" of desktop and laptop PCs for clients. The market has moved on, but Dell used to have a significant cost advantage over IBM and the rest of the firms competing in the business PC market, and they used that advantage to sell more PCs than anyone else. The standard analysis was that Dell's model of build-to-order and direct ship to customer was their cost advantage driver. Several teams I had take a look at this market for global firms all came to the same conclusion; a bigger advantage came from Dell's repair and warranty supply chain.

Standard practice, in many industries not just PC assemblers, is to develop highly analytical models using meantime to failure and other factors to determine how many of which parts are going to be needed to support the repair and warranty requirements for a product. The manfacturer will then run a production run to stock inventory to support this expected consumption. The Dell model changed the PC industry, what Dell realized was that the fleet of PCs they sold were themselves a supply chain of inventory for the repair and warranty business. They developed better models than their competitors, largely based on cannibalizing returned and broken PCs for good parts. The cost advantage from this model began at over 10% and slowly declined over several years.

Buying a cell phone this season? You may want to wait until March.

2006-12-01T14:08:00.000-05:00

If you're a Canadian and in the market for a new cell phone contract (for yourself or for your company) you should consider that wireless number portability (WLNP) is coming to Canada next March. WNLP is old news in much of Europe, Asia, and of course the US. WLNP allows a cell-phone subscriber to keep their cell-phone number when they switch service providers. For consumers it removes one of the main disincentives to switching. Few people enjoy the hassle of informing friends, family, and colleagues that they have a new cell-phone number, its probably even more disruptive than changing a home phone number as the industry doesn't have the equivalent of "411" service to find a contact's new number. Experience in the US, the UK, and many other countries shows that WLNP increases competition and decreases consumer cost. KPMG, the consulting firm, wrote a whitepaper on WLNP during the transition in the US. They identifed three major factors that will impact cell carriers; declining revenue, increasing operating costs, and declining margins.

As a consumer you won't have much opportunity to personally influence these factors, but you should see the market impact of WLNP very quickly come March. I would recommend holding off on signing up for a new multi-year wireless contract until the impact is reflected in the market. Corporate buyers should think about not only waiting for the market impact of WLNP, but also what they can do to influence the focus areas that KPMG identifies for each factor. A couple of obvious areas are to lower the cost to service your account, such as moving to web-based reporting and eliminating mailed statements. Can you allow the carrier to sell premium services or hardware directly to your employees? As always, understanding the seller's issues "market knowledge" is key to negotiating the best deal for your company.

Monopolistic Capital Market or Public Private Partnerships

2006-11-29T10:53:00.000-05:00

This week's Economist has a few articles on capital markets in the US. This one, "What's wrong with Wall Street", is the leader, and should be available to everyone. This one, "Down on the Street", is a special report, is longer, and requires a subscription. The articles discuss capital market efficiencies, and whether regulation is putting US capital markets at a disadvantage to London and other markets. I found the issues raised in context of the world's largest capital markets to mirror some thoughts I have about the very small capital market for funding Government of Canada (GoC) projects.

The GoC (or as the current prime minister would have it "Canada's New Government") spends about C$200B annually. Of that most is recurring expenditures, leaving about C$20B annually for new capital spending. Expenditures of over C$20M follow a formal approval process that includes the requirement for Treasury Board secretariat review, and depending on the value and other factors may require cabinet level approval, delegated to a committee of cabinet, the Treasury Board. This past June I participated in submissions to Treasury Board requesting just about C$170M in funding for various projects, funding that was approved by the Board. It was a rather depressing experience. Within the GoC bureaucracy it is an accepted fact that the GoC has, by definition, the lowest cost of capital, and therefore should fund all its own capital requirements. Put in another way, the GoC funds internal investments from its own captive, and monopolistic, capital market.

This is a classic error that many readers have likely already spotted. Within the procurement function we routinely review for "Total cost of ownership" (TCO). The TCO review I had our team look at for the cost of the capital investments for the submissions in June showed that, while the interest cost on the capital was the lower than that available from competitive capital markets, the pursuit costs and the opportunity costs seem to be substantially above those tolerated in competitive capital markets.

For an investment of C$170M the pursuit costs were approximately C$35M (which was also borne by the GoC), and it had taken the GoC approximately 5 years to work its way through to approval. The returns expected from the $170M are expected to be in the order of C$1B annually, of which the investment would enable the GoC to lock in $C200M immediately. I am not an expert on the workings of capital markets, but I suspect a competitive market would be able to fund projects with that profile at a substantially lower pursuit cost, and would have done so far more quickly, lowering the opportunity cost of the process as well.

The main arena that this debate is useful, is in the debate of whether "Public Private Partnerships" (PPPs) make sense for the governmental sector. Those opposed to PPPs will argue that the private sector cannot provide the same value as government self-performance as the government has a lower cost of capital and does not need to generate profit from its activities. I'll leave aside theoritical arguments for and against that view, and say that I am much more bullish on PPPs after closely observing how one government loads cost the private markets would not onto its own capital market.

OECD sees a "mild" slowdown - what do buyers think about?

2006-11-28T12:47:00.000-05:00

Today's FT is reporting that the OECD is forecasting a mild economic slowdown next year driven by the cooling off of the US housing market. Economic uncertainty, whether unexpected growth or unexpected declines, offer great opportunities on the corporate buy-side. As in all cases understanding your supplier and their industry is key. In a slowing economy your supplier may be facing underutilized production and other assets leading to a desire to lock a longer-term sales agreement. The procurement team may decide that makes sense, but they should also consider that declining markets can also offer great opportunity for opportunistic spot-buying. The decision should reflect the degree to which the good or service is of strategic value to your business.

During the last housing slow-down I helped a client, one of the largest residential housing REITs in the US, to recognize that construction material costs were relatively insignificant in relation to the companies financial performance and market value. Their business is building and operating high-end residential rental communities. Their financial returns and their share values were influenced mostly by the market's assessment of their ability to construct, generate rental income, and manage operating costs at their projected levels. The market did not react nearly as much to their ablility to construct their communities at a cost per unit that was competitive to their industry. This understanding led to a strategic decision, they used the housing start slow-down to negotiate preferential access to construction labour and materials. While price was negotiated (generally using an indexed price to the spot-market) the firm chose to value preferential supply ahead of lowest cost. That strategy really paid off over the last three years as they were able to maintain an enviable record of delivering their communities on-time during a period where many of their competitors would routinely suffer construction delays due to the booming construction sector in the US.

Mmmm Burgernomics

2006-11-27T13:19:00.000-05:00

Free exchange, the Econmist's blog has posted a note, Weighting Game, that says Big Mac burger patties vary in size by country. This could have an impact on the Big Mac index. Should the economist decide to re-weight the index for patty weight, I suggest they balance their new weighting with an understanding that patties are only a portion of the total cost of input into a Big Mac. It would be easy to overweight the weight of the patty weight in the new index.

Ivey Purchasing Managers Index

2006-11-27T10:28:00.000-05:00

Every month the University of Western Ontario's Richard Ivey School of Business and the Purchasing Management Association of Canada (PMAC) publish the Ivey Purchasing Managers Index. I'm not sure who uses the index, or where the value lies in the data they publish. One of the first things you'll notice is that there is huge month-to-month variance in the data, as shown in the table below, from October 2006. The FAQ for the site addresses the "jumpiness" by stating they don't adjust for seasonality, inflation, and covers the entire Canadian economy. As a buyer, I don't see how I could use this index to lower my cost of purchased goods and services. I wonder if the economists out there place value on it that I don't see.

Here's one that went wrong

2006-11-27T10:13:00.000-05:00

The Government of Canada has apparently decided to back away from its ambitious plan to save $2.5B through reforming its creaky procurement system. I'm very familiar with this situation, and I plan to comment as this develops. Tories can't hit $2.5B savings target.

Happy (US) Thanksgiving

2006-11-23T11:17:00.001-05:00

More bids equals higher cost?

2006-11-22T09:51:00.000-05:00

I don't like "Requests for". What buyer (or seller) hasn't been through innumerable "RFx" Requests for Proposals, Quotes, Interest, Information, etc. They are used by buyers to help them understand what the market can offer, and create competition amongst suppliers so the buyer can lower their procurement costs and, ideally, increase the quality of their supply chain.

Many organizations also like them as they structure their buying decisions in an "open and fair" manner. What is needed to understand a broader impact of these approaches is to understand that buyers don't act alone, they have counterparts on the sell side that are going to react to the approach. The sell side reacts with approaches and analysis such as "Bid Management", "Pursuit Costs", and "Success Rates". I'll give some brief examples of each below. The objective of the buyer should be to lower pursuit costs and improve seller's success rates up while not impairing the benefits of competition.

Bid Management
What buyers, and more rarely the sellers, sometimes fail to understand is that RFx often increase the cost and impairs the quality of the supply chain. Here's an article "To bid or not to bid ..." by Mark Whitley on the Institution of Engineering and Technology website that touches on some of these issues. Mark talks about bid management as a growing field of expertise and lays out the standard project management imperative triangle of time, cost, and quality. In his discussion of cost he advises that bidders consider more than direct bid costs such as bought-in costs and travel and also consider opportunity cost (what else could the team have done instead of bidding for a particular job).

Pursuit Costs
From a buyer's perspective I like to understand the pursuit costs and the related success rate. Pursuit costs are simply the costs that your bidders incur pursuing your business. These costs occur within and external to formal competition. In one memorable discussion with a white-box PC retailer I was told that his industry employed twice the number of sales people relative to revenue to service my account than they did on average for all their other accounts. It was an interesting discussion as the retailer viewed this as evidence of his industry demonstrating to us our importance. I viewed it as evidence that we were paying too much (sales costs on average were about 10%, but for us this rose to 20%) for our PCs.

Success Rate
It turns out that we not only bid our PC business to often, but we also invited to many bidders to each competition (and punished those who did not regularly bid by not inviting them into future bids). These actions had the impact of lowering the industry's success rate in competing for our business and success rate directly impacts a buyers cost. The success rate is the percentage of bids that result in revenue. If a seller bids for 10 jobs and wins 3 their success rate is 30%. Sales management tends to be pretty obsessed with success rates. Obviously a sales organization wants to increase its success rate, but it also simply wants to be able to forecast it. Sales teams spend a lot of effort building and managing the "sales pipeline" in order to be able to generate revenue. If you are on the buy side and can help to improve success rates while maintaining adequate competition everyone comes out ahead.

In another category of spend for a large client we were bidding several hundred millions of dollars for professional support for information technology services. Several thousand firms and individuals were qualified to bid and every offer over $25,000 was open to each and every firm. Some offers would receive hundreds of bid responses. The success rate for bidders was very low, and benchmark analysis showed that this was reflected in our price for these services to be high relative to the market.

Procurement teams that work to understand these market dynamics and then to structure their offers to increase competition while lowering pursuit costs and increasing success rates will end up with better suppliers at a lower cost.

Mean or Green?

2006-11-21T09:47:00.000-05:00

This weeks Economist has an article, Tilting at Windmills, that discusses the boom in investing in renewable energy technology companies. There are some interesting comments, including a reasonable one that suggests $50/barrel for crude oil is the tipping point that makes alternative energy viable, we've been at that price since early 2005.

This thought process, "at what point does it make economic sense to invest in a substitute product sector?" should be a pretty common piece of analysis in the corporate procurement world.

In the spring of this year I spoke to several hundred members of a material management organization that is largely made up of government sector buyers. It was an interesting experience as they work in a sector where policy often trumps reason. The range of policy objectives and interest groups that are factored into procurement decisions include small business, green procurement, aboriginal business, regional diversity, industry lobby groups, linquistic diversity, industrial policy, safety standards, etc. I challenged the group to consider which of these policy objectives could be supported through cost/benefit or other economic analysis.

In many cases "green procurement" can and does make good procurement sense. Here are a few examples:

a well-known global clothing retailer saved over 50% of their waste removal costs by removing cardboard (OCC) from the waste stream and generating revenue from recycling
Low-rise commercial buildings can install various technologies to pre-condition air prior to it reaching the roof-top HVAC unit. Typically these are heat-exchange units that capture the thermal value of outgoing chilled or heated air (depending on the season) prior to expelling the air. Economic payback is often 3-5 years, while government subsidies often substantially shorten that period.
including VPN capability into your secure network design adds cost, but it can enable staff to work from home, cascading into lower facility costs, and incidentally removing some carbon load from commuter traffic
In many office environments there is little thought given to the number and capacity of the printers and copiers. A recent study I looked at for two multi-story office towers showed that there were about 30% too many printers and copiers. Not only does this mean capital and maintenance costs are higher than necessary, there is a two-order impact on energy consumption. First the surplus machines consume energy, and second they generate substantial heat that requires additional energy to cool the office environment.

In every procurement decision I look at, I encourage the team to consider the entire "life cycle" cost of their decisions. What constitutes the entire life cycle cost is a whole other topic.

Equity Office Properties acquired by Blackstone. A small procurement investment would make sense.

2006-11-20T16:34:00.000-05:00

Today Blackstone announced they were acquiring EOP in a record setting leveraged buy-out worth $36B ($20B to shareholders and $16B in acquired debt). This story caught my eye as a few years back an e-marketplace I worked for served EOP and we also worked for a few months to convince their new VP Procurement to hire us for procurement services work. On the other side of the transaction a former client is now a Managing Director at Blackstone. I think this transaction can help illustrate my statement that few investments can rival procurement for generating returns for companies.

The sources and analysis appear below.

EOP has approximately $850M in sourceable spend, that is the cost purchasing of goods and services that typically can be negotiated. Based on my recall of discussions at EOP and similar REITs I estimate that approximately 50% of the spend could be addressed by strategic sourcing - $425M. Strategic sourcing in this industry typically yields savings, net of $4M in sourcing costs, of 8% or $34M in annual savings.

So apart from generating an incremental $34M to the bottom line, how else can we describe the impact an incremental investment of $4M in Blackstone's $36B acquisition of EOP achieve?

Current

Earnings per common share of Operating Income: $2.27
Earning per comon share of Net Income available to common shareholders: $0.02

After a $4M procurement investment

Earnings per common share of Operating Income: $2.35 (an incremental $0.07 per share)
Earning per common share of Net Income available to common shareholders: $0.08 (an icremental $0.06 per share)

So, the question is whether Blackstone will make room in a $36B budget for a $4M investment that quadruples the earnings per common share of net income available to common shareholders.

Source: EOP Annual Report 2005

Revenue: $3.0B
Operating Expenses: $2.1B
Operating Income: $0.9B
Net Income available to common shareholders: $8.1M
Weighted Average Common Shares Outstanding: 403,147,751

Source: Procurement Investor Analysis

Earnings per common share of Operating Income: $2.27
Earning per comon share of Net Income available to common shareholders: $0.02
Sourceable Spend: $849M (Repairs & Maintenance $341M, Property operating $442M, Corporate and general administrative $67M)
Addressable spend: $425M
Cost estimate to source $425M in addressable spend: $4M

Irrationally Rational

2006-11-20T15:49:00.000-05:00

One of the things I've observed is how difficult it is for companies to make rational investment decisions. Here's a post by Tyler Cowan linking to here that suggests many people think they make rational decisions while other people are irrational. I hope that the authors at overcoming bias continue their discussions.