Note to CEOs – The World is Upside Down

Chief executive officers, maybe you haven’t been pumping your own gas, but every one of your suppliers has, and there is no way they are going to be able to absorb 30 to 40% increases in fuel costs and stay in business. Dow Chemical just announced a 25% hike in its prices. Steel prices are also setting records. Pizza makers are spending more dough, not making it when they look at wheat prices. The world of business buying has spun completely around in the last months, and you had better sit down with your other “C-level” folks to realign your expectations of what you can deliver.
I was in a very recent meeting with managers of an equity fund who apparently have not read a newspaper in the last six months. They were still expecting the purchasing team to deliver improved margins and lower costs from the supply chain. I guess its our own fault as purchasers that over the past ten years we generally could deliver value to the bottom line by strategically managing categories, building good supplier relationships when it mattered, and mitigating risk wherever it appeared in the supply chain. CEOs have been able to wish money out of the supply chain because we could make it happen.
However, just when we had you CEOs convinced of the difference we could make, the hurricane hit, the levees broke and the world was hit with a flood of rising commodity prices. From our work with a dozen companies buying many commodities, I can tell you that what we are experiencing is a very broad trend that shows no signs of stopping.
It is time for CEO’s and CFO’s to realize that the significant decline in the economy, combined with high inflation, capacity reductions and suppliers struggling to survive have created a very different buying marketplace. Budgets built on cost improvement are now at risk. Your buying teams must focus on cost containment. In many cases they will be applying the same tools, but their goals have to fit today’s realities.

Flip the switch to Cost Containment

We enjoyed a supply managers’ market for over a decade where cost improvement and value improvement was a way of life. But record commodity prices, like $100 per barrel of oil, record wheat and soaring precious metal prices, has not only penetrated many of our supply chains, it has had a profound impact on the U.S. and global economies.
Supply managers are kidding themselves if they are not planning for cost increases in steel, aluminum, plastics, chemicals, freight, fuel, capital equipment and travel resulting from the dynamics of oil and energy markets. Many suppliers, working on already thin margins, will be aggressively pushing through price increases in 2008. Before they hit, here are three things to do to prepare for them.

1. Forecast your exposure. How much do you know about your suppliers’ cost structures? How much is actually tied up in commodity materials that are rising rapidly in price? If you can’t realistically do a full cost analysis, you can do a price analysis of your suppliers’ materials inputs. Knowing that could help create a negotiation environment where costs become transparent and the discussion turns to cost containment solutions for you and your supplier both.  For instance, there may be alternative designs or materials worth considering.

2. Condition against increases. Your expectation should be that over time your suppliers should be continuously improving — creating efficiencies that bring more value for your purchases, or lower your costs. Make it clear that price increases run against the grain of those principles. They should be hard to accept and suppliers should know that. Requesting an increase should be “difficult,” requiring the sales representative to work hard. Demand three months notice, in writing, of all increase requests and insist that they are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. A rigorous internal approval system will deter supply managers from recommending increases they might otherwise waive through because of time pressure or the desire for a quiet life.

 3. Preempt the increase. If you haven’t already, this is a good time to investigate other suppliers, prepare RFQs or RFPs and distribute them before you receive requests for higher prices. Find out what changes your suppliers have made. A new plant might have brought productivity improvements that would justify a price reduction. The same might be argued about higher volume sales covering the same overhead. Working ahead of your supplier could change the whole structure of the negotiation in your favor.

All these actions can prepare you for the inevitable.

About ADR North America

 

ADR North America, based in Ann Arbor has been a leader in purchasing consultancy for more than twenty years.

ADR North America is part of a global group of consultants – ADR International — in Australia, North America, South Africa and the United Kingdom who have worked with over 200 clients in more than 50 countries. Among our clients are many of the world’s largest companies. Our consultants are recognized experts in the field and have authored hundreds of articles and commentaries in professional journals.

Our products and consultancy services have proven their ability to transform global company purchasing operations. We can start with innovative baseline assessments, move on to create and implement purchasing category strategies, and finish by developing staff skills to bring increasing value to a company. As appropriate, our consultants can deliver all or any part of a purchasing transformation. In short, ADR is purchasing knowledge, applied.

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Ann Arbor, MI 48106
Phone: +1 734-930-5070