Tag Archives: cost containment

Risky Business-Building a Procurement Strategic Plan for 2019

It is difficult to build a strategic plan in most years, but looking forward to 2019/2020 there is a great deal of uncertainty. With the threat of trade wars, tariffs, rising prices, labor shortages, and disruptive innovation, many sourcing professionals are tossing the dice and hoping for the best. Some industries like construction, automotive, electronics and appliances are looking great through the end of 2018, but are seeing a slowing of orders and consumer demand for 2019.

Many of the experienced sourcing professionals can read the tea leaves and see suppliers pushing to turn the long-term buyer’s market to a seller’s market by an onslaught of requests for price increases citing everything from tariffs, labor and healthcare to justify the increased pricing. The successful elimination of avoidable price increases requires both a proactive and reactive approach to cost containment. The worst thing you can do is take an ad hoc approach or fail to create a plan of action. If you fail to plan, you plan to fail.

In the process described below, steps 1 through 3 are the preemptive phase and steps 4 through 9 are the reactive phase of the price increase staircase.

Preemptive cost containment
The Preemptive phase of a supplier price increase is designed to shape and change supplier expectations so they do not to attempt to raise the price to your company.

Step 1: Predict your exposure
Understand the marketplace in which you are operating. What are the potential drivers of a supplier’s request for an increase, and when will they drive the supplier to request the price increase? Ideally, you will have done a cost analysis, breaking apart the supplier’s cost to understand the cost drivers of material, labor, overhead and profit. If you are unable to do a full cost analysis, you may have done a price analysis. You and your company will be in the best position to challenge the increase.

Step 2: Ward off potential requests
Requesting a forecast of future price movements from a supplier to inform the organization’s budgeting process can be damaging. This allows suppliers to groom the organization to expect a certain level of increase and you to be pleased when the supplier asks for less. Supply management professionals must turn the tables and groom suppliers to accept the principles of continuous improvement and expect reduced costs and prices. The first agenda item for every supplier meeting should be cost and value improvement. The astute supply management professional will always reply to a “Dear Valued Customer” price increase letter with a firm return letter conditioning against the increase.

Make the process of requesting an increase “difficult,” requiring the sales representative to work hard. Demand three months’ notice, in writing, of all increase requests and insist that the invoices are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. Similarly, a rigorous internal approval system will deter supply management professionals from accepting increases without challenge because of time pressure or the desire for a quiet life. Such a program of deterrence should put the supplier on alert that price increases require approvals and that the supplier must genuinely face margin erosion for a price increase to be considered.

Step 3: Anticipate and block the increase
The supply management professional must be armed with a forecast and planned activities to pre-empt requests. Investigate alternative materials, specifications, and suppliers. In highly competitive supply chains and supply markets, it may be possible to prepare the issue of an RFI, RFQ, RFP or auction immediately before the forecasted request arriving. Gather data about suppliers that are planning increases. Have their volumes gone up (over recovery of overheads), have they built a new facility (improved productivity)? Is there a rationale for demanding a reduction ahead of their request? Offer an extension to the current contract if prices remain stable. Whatever strategy you employ, don’t sit and wait for the price request to hit your desk.

Reactive cost containment
After the supplier has sent notification of a price increase, you should take the following actions.

Step 4: Respond
It is appropriate to quickly react negatively to a supplier’s announcement of a price increase; however, delaying a personal meeting to discuss the increased pricing is a good tactic. It is essential to emphasize that cost and value improvement, not price escalation, is company policy. In the communication to the supplier:

  • Refer to the principles under which the relationship was founded (and operates)
  • Offer to work together to identify the cause and work jointly to remove and contain future increases
  • Assure that you have continuous improvement clauses in all of your agreements
  • Provide contract language indicating that all price increases require justification with factual data supporting any requests
  • Specify notice periods of 90+ days
  • Use longer payment terms to your advantage

Step 5: Oppose
If the supplier persists, base your responses upon objective data drawn from research of the cost drivers. In competitive markets, you should use the leverage from supplier rationalization and item rationalization in the competitive market.

Use the information gathered for developing preemptive action to support your view that no increase is needed. Let the supplier try to “break” your analysis rather than justify rationally for the rise. In this way, you control the agenda and are likely to reveal more information about the supplier’s cost base that would be exposed otherwise. Any costs within the supplier’s absolute control require a rigorous challenge. It is also critical to challenge that labor increases with an offset by productivity and automation.

Step 6: Corroborate
Use external sources to validate the factors claimed to contribute to the increase. If material costs are involved, sources such as CIPS-Supply Management reports can be used to confirm the movements claimed. Be aware that changes in yield/waste (continuous improvement) will be a crucial part of such validation activity. It is not sufficient to say that material Y has gone up by 5 percent; you should question whether materials have changed, reduced, light-weighted or substituted.

Step 7: Eliminate or minimize
If some level of increase appears unavoidable, then look for offsetting additional value from the supplier. Postponing the implementation of the increase by six months will halve its fiscal year impact and may “buy” valuable time to develop further tactics to avoid its effects. Other options are to lengthen payment terms, set up consignment stocks or increase year-end rebates. The sales representative will, in all likelihood, be measured only on the increase in headline prices achieved, so offsetting tactics can prove very productive.

By this stage, the supplier should understand that any negotiation is going to be difficult and underpinned by facts and data. If you are operating with a single source, it may be worthwhile introducing a cost variation clause, to provide a set of principles that govern cost and price movement.

Make it clear that any movement negotiated will remain in force until costs dictate a change, up or down, rather than for a specified period (such as 12 months). In a competitive market, however, you may wish to agree to fixed prices for a period as a buffer from anticipated cost increases. Always negotiate increased value if you are forced to accept a price increase. You can negotiate innovation, higher safety stocks, free storage, drop trailers, more top-grade materials quality improvements, and any other value component available to offset the price increase.

The critical message to drive home to suppliers is that price increase requests will not be considered merely because a specified period has elapsed. Break the cycle of annual demands for a price increase.

Step 8: Keep track and record
While price increases are not good news, they are important news. Price increases should be reported as part of supply management performance, as should cost containment achieved throughout active resistance. Such cost containment (the difference between formal requests and what was agreed) involves significant resource and yet is often invisible in management reports. If containment goes unreported, the actual contribution of supply management to a business will never be fully appreciated.

While there is no guarantee that inflation will show its ugly head, it is always best to be prepared and have a strategy when it does. There is little doubt that Savvy Sourcing Professionals will include the proactive and reactive approaches in the strategic planning process along with plans to rationalize SKU’s and suppliers if the economic conditions change.

What’s your plan?

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Where have all the ethics gone?

fingers crossed

From time to time I write on procurement ethics, but today I question where the business ethics have gone. In the past two weeks, we’ve seen:

  • Volkswagen’s Chief Executive Martin Winterkorn resigns after it was disclosed that Volkswagen will repair up to 11 million vehicles and overhaul its namesake brand following the scandal over its rigging of emissions tests.
  • Martin Shkreli, CEO of Turing Pharmaceuticals, acquired the rights to Daraprim, which was developed in the 1950s. The drug is the best treatment for a relatively rare parasitic infection. People with weakened immune systems, such as Aids patients, have come to rely on the drug, which, until recently, cost about $13.50 a dose. But when the price was raised to $750 a pill, a more than 5,000% increase, Mr. Shkreli’s brash defense of the decision has made him a pariah among patients-rights groups, industry spokespersons and politicians, making him one of the most disliked CEOs in America.
  • Stewart Parnell, the former CEO of Peanut Corporation of America, was sentenced to 28 years in prison. He had a role in concealing a 2008 and 2009 salmonella outbreak that sickened more than 700 people and killed nine.

It seems that we are seeing integrity breaches in business every day. There is a code of ethics for all business that true procurement leaders have always followed. I believe this is an area that sets apart leaders from the crowd; it’s obvious that these three CEOs lacked the integrity and leadership to do the right thing.

On a personal note, I had a mentor and boss in the early 1980s who gave me some advice and coaching that set a standard for how I operate. When I made a decision in the best interest of my company, several corporate executives wanted me to compromise my ethics and give an unfair advantage to a business owned by someone with political influence. I held my ground and my mentor said “I can’t help you and you may get fired, but there are worse things than getting fired for having integrity.” He also said “Remember, you can never put a price on integrity.” These were wise words and some advice that these three executives either never received or chose to ignore when faced with the choice between profit and principles.

I must not be alone in questioning ethics; this morning’s HBR Management Tip of the Day is Know When to Speak Up About an Ethical Issue. Is it time for your firm to think about reinforcing the company ethics standards and conducting an integrity audit?

Does your reputation have a price?

Interest Rates and Cost Control—it’s been a wonderful life

Broken-piggybank

10 tips to control costs

This WSJ headline caught my attention: Fed’s Fischer: ‘Good Reason’ to Think U.S. Inflation Will Move Higher.  Vice chairman says Fed shouldn’t ‘wait until inflation is back to 2% to begin tightening.’  This should serve as a warning to all companies that the good times may be nearing an end and we may be experiencing the switch from a buyer’s to seller’s market.

Should interest rates rise, many suppliers and supply chains will feel the significant impact of severely extended payment terms. We’ve been working in an economy where the cost of money is relatively low; as interest rates rise, suppliers and the entire supply chain will be impacted by added costs to support the extended terms. As these costs increase, there’s an additional risk that the front-end of the supply chain may not be able to fund or pass through increased costs, causing severe supply chain risk.

Sourcing practitioners have basically two options for dealing with cost containment: wait until the supplier increases the price, then react, or proactively create a cost containment plan that involves the entire organization.

Good proactive cost containment plans require these 10 actions:

  1. Improvement of functional inter-site and intra-business collaboration
  2. Monitoring external markets and market pressure for price increases
  3. Forecasting the impact of potential price increases on the business
  4. Reviewing all contracts to solidify current pricing and prioritizing cost containment targets with quantified objectives
  5. Researching market and supplier data
  6. Building a supply chain map
  7. Running risk assessments on the supply chain
  8. Conditioning suppliers against price increases
  9. Building tactics for delay
  10. Deterring price increases

I have been around long enough to experience cycles of inflation and these actions have been proven successful when dealing with inflation. The difference today with the inflationary periods of the past are that the extended payment terms across the supply chain make some of the suppliers extremely vulnerable to the increased cost for money.

Sometimes forecasting the economy is like using a Ouija board, but all signs are pointing to interest rate hikes, hence, inflation. So, should you wait? I see it like this, borrowing a quote from Clarence in It’s a Wonderful Life, “You see, George, you’ve really had a wonderful life. Don’t you see what a mistake it would be to throw it away?”

Are you ready for a Seller’s Market?

Economy predictions and interest rate hikes: Is it a buyer’s or seller’s market?

Setting your strategy through 2016

In today’s economic environment, how should procurement professionals look at the market?

Let’s review the forecasts. Most economists are forecasting growth through 2015 and accelerated growth through 2016 with leading forecasters predicting that the world economy will grow between 2.8 and 3.0%. Looking at the October 2014 forecast of the International Monetary Fund (IMF), world growth was measured at 3.3% for 2014. There is little doubt that the US is leading the way with strong performance and lower unemployment numbers. However, while Janet Yellen sees “some of the headwinds that have been holding the economy back are beginning to recede” and sees a possible interest rate hike in as a sign the economy is healthy, what impact will a possible June interest rate increase have on the tricky financial supply chain?

As I review these numbers, consider the decline in oil pricing, increase in consumer spending and predictions of a strong global economy, I am placing my bet that the buyer’s market of cost containment, available supplies and increasing volumes back to pre-recession levels is here for a while, even if interest rates start to raise this summer.

Buyer’s market is great news as procurement professionals prepare plans for 2016. It’s always a challenge and worry when setting standards and budgets, but it looks like buyers can go forward with a great deal of confidence. Understanding the macro and microeconomics is an essential skill required by any purchasing professional.

Go forward with some confidence and capitalize on the buyer’s market as long as you can.

Make hay while the sun shines.

Will cost containment make a comeback in 2015?

Is the labor market “ripe for a lift off “ as reported by The Wall Street Journal? We’ve seen Wal-Mart raise the wages for 500,000 employees and we are seeing many states legislate increased minimum wages for workers. The employment market is showing its strongest growth in jobs since 1997 and all indications are that wage increases will continue after such a slow recovery from the recession.

It should come as no surprise to astute procurement professionals that rising employment costs will soon trigger price increase announcements. It’s time to actively monitor the supply base, keeping a check on key suppliers, create a message for expectation management, audit suppliers for productivity gains and build an effective strategy for containment action.

Don’t be surprised if suppliers capitalize on increasing labor markets to bolster prices and margins. So, like the scout motto,

Be Prepared.

The cost of being a bad customer

If John Henke’s calculations are accurate, General Motors could boost its operating income by $400 million per year just by improving its relationships with its suppliers. For Ford the number is $327 million, and Chrysler, $308 million.

We are not alone in claiming that suppliers don’t give their best stuff to their worst customers, but Henke, who is a Ph.D. and president and CEO of Planning Perspectives, Inc. has finally projected a dollar cost for bad relationships. He’s been studying supplier relationships and cost concessions within the automotive industry for many years, and he developed an index to measure it.

For the first time ever, however, Henke used proprietary data his firm has collected, public records, and media reports to calculate the costs when suppliers do such things as shift their innovations, A-Team support, or added value service to other customers. Foreign automakers have been able to take advantage of those shifts and have saved significantly over time as a result, according to Henke.

You might quibble with Henke’s formula, but the conclusion is pretty solid for any manufacturer in any sector. Beating up suppliers on price is a short-term tactic, not a long-term strategy for profitability. Are the Big Three listening? Here’s an Automotive News video report with Ford’s chief purchaser sounding like he’s read the study and is trying to catch up, while Toyota’s purchasing chief is taking steps to shore up his declining supplier scores.

 

White House endorses quicker supplier payments

One of the maxims of this blog is, “Suppliers don’t offer their best ideas to their worst customers,” and one of the quickest routes to the category of “worst customer” is stretching out payments to 60, 90 or  120 days — as has been fashionable in the automotive and other industries. We generally applaud the idea of thinking like a CFO when you are a supply manager, but too often the finance-department led idea of pushing the cost of money onto suppliers by delaying payments results in tighter margins for the supply base that stifle reinvestment in equipment or research and development.

Apparently President Obama has come around to our thinking on the topic because he recently endorsed an organization of companies that have pledged to pay suppliers quickly, or help them find lower cost working capital.

In the White House announcement, the Administration claims its QuickPay program of paying small government contractors quickly has saved them $1 billion since 2011. The private business version of the program, called SupplierPay is an opportunity not just to save money, but to create better relationships that foster innovation.