Tag Archives: procurement strategy

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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Negotiating with Consultants – the insider perspective

goats-competition-dispute

In the indirect category one of the tricky negotiations is consultants. In many cases, they are brought in at high levels of the organization for their specific expertise. Often they have already been awarded the job and are ready to start the assignment with the contract being the cleanup details. Has this ever happened to you? In this blog I’ll give you hints to improve negotiations with consultants.

The types of consultants will vary by specialty and market. It’s important to understand that all consultants are not strategic. Let’s look at a way to determine types of consultants.

types-of-consultants

In Pillars 1 & 2, the power rests with the hiring company and can be tactical in nature. For Pillars 3 & 4 the consultants often have the power and the negotiations must be more strategic, outlining the principles around the engagement and the relationship. The larger firms relate fees to the value perception of the customer rather than a cost-based formula. The consulting firm typically deals with the prospective customer’s senior management and provides several options for solving business issues. Many of these options will be conceptual, leaving the project details open to be negotiated. The key cost drivers for the consulting firm are margin goals, staff utilization and opportunity cost, which are presented to the prospective customer as staffing for the project and timeline.

Pricing methods
The decision on pricing methods depends on the nature of the agreement and whether a performance element is involved. This can also be tackled on an assignment-by-assignment basis. The options for pricing are to develop a structure not linked to performance or link consultant performance to milestones and deliverables.

Options include:

-Pricing not linked to performance. Approaches include:

  • Hourly rates, daily rates, weekly rates, monthly rates
  • Differential rates: partners, seniors, juniors
  • Fixed fees: annual, monthly, weekly, project [turnkey contract]
  • Retainer fees

-Pricing linked to performance. Approaches include:

  1. Performance lump sum pricing—the parties agree a charge for work that will achieve a specified target. The service provider works whatever hours are necessary to meet the target.
  2. Target pricing—the parties agree a price for performing a task or for meeting a target based upon estimated days at a nominal daily rate. A sliding scale may be applied if the actual days are more or less than estimated days:
    1. Fewer days warrant higher per diem rate
    2. More days warrant a lower per diem rate
  3. Performance fee—the partners agree a mix of charges between daily/project rates, retainer fees and a performance fee based on an agreed quantum, linked to specified deliverables.
  4. Milestone based fee‒A fixed fee based on a retained with milestone payments and performance payments based on deliverables is achievable, although the consulting firm may resist this option.

The consultant may offer a performance only fee since some managers like for the consultant to have skin in the game, but there is usually a dispute at the end of the assignments about who had the idea, when was the idea generated, the ideas the company does not want to implement and who ultimately has accountability for either product or supplier failure. One of my assignments generated over $400,000,000 in savings; if there had been a 30-40% gain share (the typical rate), the client would have been unhappy with the payment even though the value was achieved.

Key negotiation tactics
Staffing the project:

The first consideration is to understand who is staffing the project. The negotiator must dig into the background of each consultant and understand their capabilities roles, accountability and responsibilities. It’s essential at the start of the project to define what work will be assigned to each level of consultant. It’s also important to negotiate the role of the managing consultant and the time that will be spent on the project.

Caution–Bait and Switch: One thing that some larger consultants do is start the project with a top-class team then remove the team and replace it with lower level people once the project has started. It is essential that the negotiator insists and documents that the players that start the project will remain through to the completion of the project.

Pay for Performance:

The key part of the program revolves around the project scope, milestones, deliverables and time line. All of these must be detailed in the scope of work (SOW). The negotiator should develop a series of progress payments and incentives for meeting the project deliverable rather than a time and materials contract. The goal of any successful consulting assignment is one where the deliverables are met and the company succeeds based on the work done. The negotiation is all about achieving value for money and performance.

Caution–Resistance to performance payments: Many consultants are not held accountable for meeting all of the project deliverables and will extend timelines with scope creep as a way of increasing revenue and finding other areas to extend their longevity in the business. Milestone and performance payments keep the consultants efficient and focused one the task and deliverables at hand.

While we focus on fees, it is much more important to quantify the objectives and deliverables at the front-end of any assignment. Unfortunately, the stakeholders are trying to quickly address a business issue and are unlikely to want to dig into the detail. As procurement professionals, it’s our job to educate and influence stakeholders to ensure that the service being provided meets the expectations of the company at the agreed fee rates. Performance payments and a team that remains with the assignment from the start will take you far.

How do you negotiate with consultants?

Commodities Could Be Trouble in 2017

money-crop

Have we been lured into complacency with commodities that have fallen over the past year impacting cost of major raw materials and our profitability? With corn over 40% down, copper 38% down and wheat more than 30% down, it is apparent that we have enjoyed significant market opportunities. Having traded commodities in my career, I know that commodities run on a cycle and the good times may be close to an end. A good example of commodity cycles is peanuts, where prices rose 33% in 2016, but bumper crops were expected in the current season, which should drive prices down. Today in the Spend Matters guest post US Peanut Prices Increase More Than 30% in 2016, Mintec noted persistent rains in China have caused high moisture levels in the peanut crop, which will greatly affect quality and price.

In a Bloomberg report on Barclays Black Swan Threats to Commodities, there is upside risk for raw materials in 2017 and the likelihood of further upside risk based on radical changes in the global economy, energy markets and global political risks on trade. Another dynamic that could impact all buyers involved in international trade is the opportunity and potential for disruption and risk posed by currency. With Switzerland announcing that it’s abandoning its peg to the Euro, the unknown impact of Brexit and China changing how exchange rates are fixed, it could signal volatility.

In many companies, procurement and finance have a joint obligation to protect the company’s profit plan. The goal of managing commodities and currency is not to speculate, but to assure the profitability across the organization is maintained. If you’re planning a commodity or currency strategy, here are three approaches to consider:

  1. Cover 70 to 80% of the plan, leaving 20 to 30% flexibility to move with key markets
  2. Develop formula-based pricing levels
  3. Work with finance to build currency hedging by buying foreign currency or by changing contract pricing to US dollars

It does make sense to look on the horizon for any currency or commodity that might pose potential risks and build the plan prior to any change in market pricing. There is no doubt that 2017 will bring a new frontier to global trade and it’s best to be prepared, rather than be surprised.

How will you manage volatility should it arise?

Driving Supplier Diversity- Numbers game or serious business?

woman-worker

Why your program is ineffective

In my career I have been astounded by the corporate mandates to increase supplier diversity that occur without a strategy or plan. Corporate directives are typically to find minority suppliers and get the numbers up. The process buyers frequently use to do this is simple: cast the net, bring in diverse suppliers and get them on-boarded so they can be counted to allow their companies to compete for government work. The big conflict arises when the other directive given to procurement is to drive maximum cost and value improvement. When this happens, the diversity program usually does not include supplier development and many of the diverse suppliers are unable to compete on price with larger, well capitalized businesses (that will eventually replace them). Every year the process is repeated: cast out the net, bring in new suppliers and replace the suppliers that are unable to compete on price.

What can be done to stop this cycle? The only way the supplier diversity process can work is to attract diverse suppliers, develop them and build strong relationships that will endure over time. To do that, a company must be committed to work with the diverse suppliers, understand their business and assist them in building a growth plan for your business. This may include long-term contracting for finance purposes and forgoing the benefits of long payment terms for these suppliers.

Supplier relationship management is essential for all strategic suppliers, but it is critical if you want to succeed with a stable diversity program. Many of these firms are disadvantaged to begin with, based on access to growth capital, talent and networks. When we add reduction of margin through price reductions and terms extensions, they have little to no chance to remain as suppliers. One diverse client that I worked with was forced to use customer directed priced materials at fixed labor rates and a fixed overhead rate with a net margin of 2%. This supplier lost the business to low cost country suppliers who reduced the cost an additional 1%. This diverse supplier never had a chance–given capital he could have automated several operations, providing the OEM a 5% reduction and increased his margin 2%.

If your firm does not have:

  1. Budget for diversity development
  2. Strategy and process for attracting and on-boarding diverse suppliers
  3. Formal supplier relationship management process
  4. Fast payment terms
  5. Timelines for growing diversity programs and its suppliers

You may be paying lip service to supplier diversity.

Review your strategy, budget for developing suppliers and recognize:

“Suppliers are only as good as we let them be.”
David Johnson, Campbell Soup

Managing when revenue is down

sign-slippery-wet-caution

This week’s Wall Street Journal really made me think about how procurement and Supply Chain Professionals must modify strategic direction to help their firms survive; Apple’s overall revenue declined 14.6 %. Caterpillar reported another sharp decline and cut back its outlook indicating the 4-year slide will continue and 3M also trimmed its sales outlook.

While these news stories show slow economic growth, they should serve as an alarm to professionals in procurement and supply chain–it is essential that the total focus includes process redesign, aligning the supply chain and implementing lean techniques. From my experience, I understand that cost improvement is the key to survival to organizations experiencing sales decline.

  1. Supply chain leaders must understand lean and apply waste reduction and productivity improvement across all tiers of the supply chain. When profits are falling, it is essential that all organizations capture all leakage of profits through waste and lost productivity.
  2. Procurement and supply chain processes be reviewed and redesigned to assure that the total focus and mission relates to cost improvement, which assure that all effort is dedicated to the task at hand maintaining profitability in the wake of falling sales. This doesn’t mean just price reduction, but true total cost improvement.
  3. Procurement must align its suppliers with the mission of cost improvement. Suppliers must understand that the current economic conditions require supply chain alignment and lower cost to survive declining sales.

While these things are common sense, it is essential that as supply chain and procurement leaders, we have a direct impact on profitability, shareholder value and, ultimately, we have a fiduciary duty to help the organization weather the economic storm and survive.

We asked for a seat at the table; the time for action is now.