23 July 2008
Mike Buchanan, chief executive of LPS and author of new book Profitable Buying Strategies, outlines whether procurement is ready to handle price inflationThe reasonable man adapts himself to the world.
An unreasonable one persists in trying to adapt the world to himself.
Therefore all progress depends on the unreasonable man.
George Bernard Shaw
Man and Superman (1903)
How well are purchasing professionals equipped to fight the looming inflationary pressures in the economy, from both national and international sources? Among purchasers of a certain age, there must be many who recall what purchasing was like in the mid 1970s. Between November 1973 and December 1977 price inflation in the UK never fell below 10 per cent, and it peaked at 26.9 per cent in August 1975. The overwhelming purchasing challenge at that time was to fight vendor price increase applications, which arrived with monotonous frequency, often on a quarterly or even monthly basis.
But the purchasing challenge was arguably simpler then. As long as the typical purchasing department supplied its organisation with materials and services in a timely fashion, and kept costs within budget, the department would attract little interest or criticism. Purchasing was synonymous with cost management and contract negotiation and management, to executives inside and outside the purchasing profession. CSR, sustainable procurement, supplier diversity and more were not on the agenda.
Managing costs in the UK's low-inflation environment over recent years has obviously been easier than in the high-inflation environment of yesteryear. But has this led to purchasers becoming poor cost managers? After all, many buyers, especially the younger ones, didn't experience the tough years of the 1970s and 1980s.
The spectre of rising price inflation is here again, and governments have little influence over the key drivers. So once again it will fall upon the shoulders of procurement to manage costs expertly. How well equipped are they to meet that challenge?
While writing my forthcoming guide to cost reduction, Profitable Buying Strategies: How to Cut Purchasing Costs and Buy Your Way to Higher Profits
, I reflected on the level of cost management competence I found among buyers in recent years. My conclusion? Too many purchasers simply aren't managing costs very well, and they use a very limited range of tools and techniques. This also holds true for many buyers who have undertaken extensive - and expensive - professional development.
Since 1999 I have made a modest living as a purchasing consultant and interim. I routinely save my clients millions of pounds each year, using the principles outlined in the book. I believe there are ten keys to cost reduction: areas which needed to be recognised and acted upon if cost management is to be of a high standard. Each key is the subject of a chapter in the book:1. Appropriate buying philosophy and psychology
These underpin all cost management activities. But I have met numerous buyers who simply don't have the mindset to be effective cost managers: square pegs in round holes, so to speak. Somehow they stumbled into purchasing, and they're temperamentally unsuited to the challenging task of effectively managing costs.2. The use of a small number of important buying concepts
I'm referring here to the 'basics' of buying: the buying portfolio, the buying cycle, Pareto analysis, total cost of ownership, and so on. Now here's an interesting thing: while there is widespread understanding of such concepts in the profession, this generally not matched by intelligent application of them.3. The use of effective tools and techniques
In this area I include tools and techniques such as spend mapping, estimating and targeting cost saving opportunities, understanding and challenging specifications, and price benchmarking. I'm not a fan of price benchmarking, and I explain why.4. The use of a wide range of changes to deliver cost reductions
Purchasing consultants frequently report a phenomenon which may surprise the reader. It concerns the cost reduction potential in an individual client's spend areas. Common sense might suggest that the cost reduction potential would be inversely proportional to the length of time that a given employee has been responsible for the area. We may be told that an employee has, say, 10 years' experience in the spend area, so we shouldn't expect to find significant cost reduction potential. But my frequent experience, and that of my colleagues, has often been that cost reduction potential is directly proportional to the length of time that an employee has been responsible for a spend area. That is, the longer the duration, the greater the cost saving opportunity. What might explain this?
We often report to clients that an employee doesn't have ten years' experience, he has one year's experience, 10 times over. That is, the individual settled on a preferred approach 10 years ago, and has been managing the area the same way ever since. Whenever I hear the '10 years' experience' line, I hear the sound of an old-fashioned cash register - 'Kerching!' - especially if I hear that the employee hasn't changed his or her vendor(s) over that long period.
Many people are simply averse to change, and this is unfortunate in this context. Because good cost managers are fond of change, they like to systematically and energetically explore a wide range of options, changing what is bought, how it is bought, when it is bought, where it is bought from, rent versus buy, and so on.5. The extensive use of market testing
Market testing is at the heart of most successful cost reduction initiatives. It provides an opportunity - possibly a rare one - for a number of viable new vendors to gain a new customer, which is obviously important to them. But time and again I come across buyers who are reluctant to carry out market testing, often on very weak grounds. This chapter includes advice on different types of market testing (RFI, RFP, RFQ and ITT), and when and where to use them. Templates of a Request for Proposal and a Service Level Agreement may be downloaded from my company's website, www.lpsconsulting.co.uk.The chapter also covers the issue of locating potential new vendors, buying internationally, market testing in difficult markets, and it includes a number of market testing case studies.6. The use of appropriate outsourcing and insourcing
This chapter covers the issue of what to outsource, levels of outsourcing (tactical, strategic or transformational), major legal issues to consider, and insourcing - that is, bringing in-house what has hitherto been carried out by third parties. Insourcing may even follow a previous successful outsourcing, and Sainsbury's provides an interesting example of this. In its 2006/7 annual report, the company reported that it had increased its cost savings target to £440 million (from £400 million) following its insourcing of IT in April 2006, and it was on track to deliver the higher sum.7. Use of a range of negotiation tools and techniques
Purchasing consultants - well, the successful ones anyway - generally enjoy challenging people and challenging established ways of doing things. They are, to many people, unreasonable. In negotiations, they are blissfully unconcerned whether the vendor facing them across the desk considers them reasonable or not. I meet too many purchasers who are keen to reach a mutually amicable compromise with vendors, which gives the vendor a major tactical advantage.
This chapter covers the issue of developing your negotiating abilities, the five golden rules of effective negotiation, minimum and maximum settling points, and 'the killer question'. There is also advice on vendor pre-conditioning and leveraging your buying power.8. Understanding of contract law and use of appropriate terms
A contract register template and sections on contract durations, contract termination terms, contract terms, and the buying cycle, should prove useful to even the most seasoned procurement professionals.9. Use of e-procurement
While some buyers are enthusiastic users of e-procurement, far too many are resistant to it, even in the most appropriate circumstances. Simple resistance to change again? This chapter provides a brief introduction to auctions (Dutch, Chinese, reverse, electronic and English) and e-procurement terminology. It charts the development of e-procurement over recent years and anticipates where it is heading. It includes e-auction do's and don'ts and an overview of e-procurement by The Aberdeen Group.
The chapter also provides case studies from three e-procurement enablers: BravoSolution, Procuri and Vendigital. The BravoSolution case study is particularly interesting, not only because it involves a major public sector organisation (the National Health Service), but also because it concerns a spend area that many might think unsuitable for an e-auction: namely, temporary staff. The NHS is forecasting savings of over £100 million as a result of a three-day-long e-auction, and both the number of agencies and the administration burden of the organisation have been reduced. The resultant time savings for the NHS have been considerable, leading to significant performance and productivity improvements.10. Recognition and management of organisational issues
This chapter covers organisational politics, buying development stages, approaches to buying, and building buying capacity and capability through employees, interim managers, and consultants. It also covers maximising the value derived from external experts, matching buyer personalities and aptitudes to tasks, and buyer motivation and incentivisation. Also considered are individuals' roles, responsibilities and authorities, buyers' product knowledge, buyers' contract law knowledge, buyers' competence development, performance measurement and reporting, and ethics.
The book contains 20 cost reduction case studies, and the following appendices:
1. Service Level Agreement (SLA)
2. Request for Proposal (RFP)
3. CIPS (about the organisation, membership, training and events, and the Professional Code of Ethics)
4. Soft issues impacting on cost reduction drives (corporate social responsibility, sustainable procurement, diversity issues, environmental considerations, and improving the income of poor producers)
5. Buying at Sainsbury's supermarkets (overview, goods and services for resale, and goods and services not for resale)
6. Buying at SmithKline Beecham (details of the 'Simply Better Purchasing' initiative credited with delivering cost savings of over £200 million in the early to mid 1990s - structuring an effective cost management programme, tactical control through purchasing category management, buying at the right geographical level, impacting total cost of acquisition, and determining appropriate category strategies)
7. Buyer remuneration in the UK (the Purcon Salary Study)
My simple message to the profession? Let's take a fresh look at our cost management activities and employ a far wider range of tools and techniques to reduce our organisations' costs.
Mike Buchanan, chief executive of LPS, is the author of Profitable Buying Strategies, published by Kogan Page (www.koganpage.com)
The book will be reviewed in a future issue of Supply Management.