Tag Archives: cost management

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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Are you prepared for a labor increase?

winter

How the new overtime laws impact your organization

On May 18, 2016 the U.S. Department of Labor released the update to the Fair Labor Standards Act overtime rules. Simply put, starting December 1 2016, the classification for employees exempt from overtime will be raised from $23,660 to $47,476. This change makes millions of workers eligible for overtime when they work more than 40 hours.

For many procurement and supply chain leaders, this should be a consideration as we rapidly approach the budgeting season, not only for increased fee rates from service suppliers, but also for your department salaries. Many times to meet RFP, RFQ and project deadlines, staff will work into the night to get it done. While you may have had a comp time policy for exempt employees, now you could be paying time and a half or double time to get projects completed. There will be implications if junior staff travels for conferences, supplier visits or training and across a wide spectrum of work. You will need to think of the impact of all of these scenarios on your cost.

It is good to prepare now for this change. Here are some thoughts that may be useful in planning:

  1. If you have not automated the P2P systems and processes, this change could provide the economic justification that has not been available in the past.
  2. Review the exempt status of all employees.
  3. Analyze the current hours worked and salary implications of this change.
  4. Review the salary ranges for all job roles. Decide if some salaries should be raised, if job descriptions accurately describe the job role and if the compensation matches the responsibilities. I know, this is a HUGE task. If staff is consistently working more than 40 hours per week, is the headcount right?
  5. Look for opportunities to automate, reduce unnecessary work and increase productivity.

While these are some initial thoughts, I suggest you have a strategy session with your HR group to understand the company policy on the changing position for the cost of labor. If you haven’t done the analysis or the company does not yet have a position, the time to act is now.

Don’t let December arrive before you’re ready.

Winter is coming.

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?

Lower Diesel Prices: 5 things to do now

diesel

How fast does your team react to available data?

In Supply Chain24/7’s news yesterday, the headline read diesel prices decline for the 12th straight week. “At an average of $2.615 per gallon, the price is down 0.2 cents compared to last week, with prices dropping a cumulative 29.9 cents going back to the week of May 25, when the average price was at $2.914.” What will you do with this data?

The challenge for the procurement and logistics teams is translating this data into cost reductions. There should be a parade of transportation companies eliminating surcharges and reducing cost, but I’m guessing suppliers aren’t coming to you. Your team should be acting on their plan for value enhancement now. One of the key characteristics of a good cost manager is to constantly monitor the suppliers and the supply markets. While there is no doubt that the fuel cost structure for for all freight companies is declining, they’re probably constructing arguments for other areas where costs have gone up. Customers should be prepared for this and be sure that their cost structure reflects the market changes.

Astute supply chain practitioners realize that, if unchallenged, the logistics suppliers will have the opportunity to significantly improve margins, while their costs are essentially remaining the same. The savvy purchaser will:

  1. Know the impact of fuel on the pricing structure
  2. Ask for the appropriate decrease
  3. Shake up the market with a competitive bid (if suppliers are unwilling to pass along the lower cost)
  4. Develop a longer term hedging strategy
  5. File away the lower fuel price impact data for use in the next negotiation.

What is your plan?

10 Megatrends for Supply Chain Management—where will you be in 2020?

srm chain

Developing Strategies for Success

2015 is becoming the year of the merger, which means industry consolidation, megamergers and industry consolidation across most supply chains. This trend is driving many companies to develop exclusive, integrated, competing supply chains. Companies that have advanced this practice are Apple, Samsung and Toyota with end to end integration serving the final customer. The key drivers of this type of supply chain are cost transparency, value creation, integrated business systems and innovation. Is your company on top of the trends that shape your supply chains?

To gain control of supply chains, you need to have a good understanding of the trends that will shape supply chains in the coming years. The 10 megatrends I’m seeing are:

  1. Supplier relationship management is becoming a core competency
  2. Value creation is more desired than price management in the future
  3. Innovation transfer is required for the success of the entire supply chain
  4. There is a movement toward portable manufacturing
  5. Contingent work forces are becoming more prevalent in business
  6. Internal and external collaboration is a business requirement
  7. Business strategy alignment will be required between all links in the supply chain
  8. Distribution, logistics and asset management will be a bigger priority
  9. Life cycles are becoming shorter
  10. Supply chain and manufacturing agility will be required to dominate competition

The supply chain management function has been evolving to keep pace with the changing trends. I’ve seen many companies struggle to keep up—those who make the investment to develop skills and improve processes succeed. The diagram below shows some of the key trends that have impacted and evolved supply chain management.

Evolution of SCM

As I see it, it is essential to move from a customer/supplier relationship to an integrated supply chain focus. While some companies have made the leap and lead their industries, others are still back in the price management focus.

Can you make the leap?

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.