Purchasing technology company that "gets it"

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 ...

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

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

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?

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?

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

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

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

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?

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:

1. Identified Savings
2. Front End Rebates
3. Back End Rebates
4. Transaction Payments
5. 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

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

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