I am a sourcing professional and my husband is a sales executive. This has made for some interesting dinner conversations over the last 30 years. I am currently working with a client on a sourcing event. The client’s sole source vendor (a distributor) has wisely placed significant “free” equipment on site which, of course, uses proprietary materials. The client doesn’t want to incur the significant switching costs nor the disruption to its operation by changing vendors. The requirements include other standard products which could easily be purchased elsewhere, but the client also wants a sole source. The distributor manages inventory for stock items on a kanban basis making the lives of the buyer and his internal customers very easy.
Over coffee, my husband acknowledged that this is a sales rep’s dream situation! The customer is “locked in” with high switching costs thereby eliminating competition. He further admitted that this situation would most likely result in higher than normal profit margins for the vendor. Conversely, this situation is a buyer’s nightmare! How does one realistically introduce competition given the circumstances? A couple of possibilities come to mind. First, we can potentially create competition among various distributors who can supply the same equipment and proprietary materials as well as the standard items. However, that could require changing out the equipment, and it remains to be seen whether the distributors will bid against one another. Another option is to take the proprietary materials off the table and bid out the remaining standard products. However, this would violate the sole source objective, and one should only pursue this if there is a sincere willingness to split the business assuming the savings justify. Bluffing with potential bidders will only damage any long term potential for competition.
It’s unclear at this point which option we’ll take. Bidding the non-proprietary products will potentially allow the client to see the premium he’s paying for the standard supplies in order to maintain a sole source. The risk, however, is that the incumbent distributor will subsidize pricing on the stock items to maintain this business and make his profit on the proprietary products. Not an ideal situation.
As sourcing professionals, our best approach is to avoid these situations to begin with. We need to help our internal customers understand that there is no such thing as “free”. We need to look at not only the short term savings for “freebies”, but also consider the long term effect on competition and the resulting impact on pricing. Without competition, we’ll never know the true cost for the “free” equipment.
Originally posted on E-Sourcing Forum: http://www.esourcingforum.com/archives/2009/04/30/take-a-long-term-view/
Thursday, April 30, 2009
Saturday, April 18, 2009
The Demise of Strategic Sourcing
In a recent Supply & Demand Chain Executive article entitled “Sourcing Prediction: Why the Future of Spend Management Won’t Include Its Most Familiar Component”, David Clevenger, VP at Corporate United, predicts the demise of strategic sourcing. He believes that strategic sourcing has run its course because the “piece-price savings aspect of nearly everything a company procures has been exhausted” and “low-hanging fruit has been harvested several times over”. This statement reminds me of the US Patent Office Commissioner’s declaration in 1899 that “Everything that can be invented has been invented.” Clevenger goes on to argue that the future of spend management lies in “advanced supplier and contract management, combined with sophisticated supplier development and analytics to identify and quantify new generations of savings to buying organizations.” He advises spend managers to pursue “real, productive and lasting relationships with suppliers.”
I am completely in favor of supplier relationship and contract management. However, I have several issues with Mr. Clevenger’s prediction. First, he assumes there is an absolute floor to prices. That is obviously not true as we have seen with electronics prices over the last several decades. His position assumes market forces have no impact on pricing and that there are no process or other efficiencies that result in supplier savings. With all due respect, I also think Mr. Clevenger missed the concept of “strategic” in strategic sourcing. The type of supplier partnership he describes is appropriate in certain circumstances where few options exist and there is mutual dependency between the buyer and supplier. However, there are many more situations where competition will deliver the best value (price, quality, service, etc.) to the buyer. On a personal level, do you think a “partnership” with your wireless provider or local car dealer will deliver the best results? I think not!
As sourcing professionals, we need to examine each situation and determine what is the right strategy, then do the appropriate research to assess and source best value. Where supplier partnerships are appropriate, we should pursue them with excellence. However, there remain many circumstances where a competitive approach makes sense. I predict that strategic sourcing, including competitive bidding, will be around for a long time to come. With deference to Mark Twain, the reports of its death are greatly exaggerated!
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on SpendMatters.com http://www.spendmatters.com/index.cfm/2009/4/17/Friday-Guest-Rant-The-Demise-of-Strategic-Sourcing
I am completely in favor of supplier relationship and contract management. However, I have several issues with Mr. Clevenger’s prediction. First, he assumes there is an absolute floor to prices. That is obviously not true as we have seen with electronics prices over the last several decades. His position assumes market forces have no impact on pricing and that there are no process or other efficiencies that result in supplier savings. With all due respect, I also think Mr. Clevenger missed the concept of “strategic” in strategic sourcing. The type of supplier partnership he describes is appropriate in certain circumstances where few options exist and there is mutual dependency between the buyer and supplier. However, there are many more situations where competition will deliver the best value (price, quality, service, etc.) to the buyer. On a personal level, do you think a “partnership” with your wireless provider or local car dealer will deliver the best results? I think not!
As sourcing professionals, we need to examine each situation and determine what is the right strategy, then do the appropriate research to assess and source best value. Where supplier partnerships are appropriate, we should pursue them with excellence. However, there remain many circumstances where a competitive approach makes sense. I predict that strategic sourcing, including competitive bidding, will be around for a long time to come. With deference to Mark Twain, the reports of its death are greatly exaggerated!
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on SpendMatters.com http://www.spendmatters.com/index.cfm/2009/4/17/Friday-Guest-Rant-The-Demise-of-Strategic-Sourcing
Carpe Diem!
In today’s economic climate, most companies are under tremendous pressure to reduce costs and improve profitability. Targeting cost reduction from purchased goods and services is a wise choice since every dollar saved goes directly to bottom line profit. Now is the time to move aggressively with these efforts as many markets have switched from Sellers’ markets to Buyers’ markets presenting tremendous opportunities for sourcing initiatives to reduce costs. Carpe diem! Seize the day!
Unfortunately, in-house sourcing organizations are already stretched to the limit leaving numerous untapped opportunities. Many purchasing organizations have cut staff, and further reductions may be underway. There are no budget dollars to hire additional sourcing staff nor to bring in external consultants to reap the benefits these market conditions present.
What is the business justification to address this dilemma? According to Aberdeen*, the average company has only between 51% and 90% of spend under management, and every new dollar brought under management nets a 5-20% cost reduction. Let’s assume your company is better than average with 80% of spend under management. That means 20% of spend is unmanaged. For every $10 million spent on purchased goods and services that leaves $2 million unmanaged. Since every new dollar brought under management nets a 5-20% savings, the $2 million of newly managed spend would deliver $100,000 and $400,000 in savings and bottom line profit! Assuming your company’s profit margin is 20%, you would need to increase revenue by $500,000 to $2 million to realize the same profit improvement. In other words, the opportunity is enormous!
Sourcing-as-as-Service using gain sharing can fill you resource gap with no upfront cost or risk thereby allowing you to seize these cost reduction/profit improvement opportunities. Paladin Associates and others offer this option. Since you need to move quickly, you’ll want to select a firm with seasoned professionals who can “hit the ground running”, and who employ the best processes and the latest technology. You’ll also want an organization with experience across a broad array of categories (both direct and indirect goods and services).
Not getting the support you need? Partner with your CFO. He or she can help you cut through the organization politics and sell the profit potential Sourcing-as-a-Service offers. Carpe diem! Seize the day!
Barb Ardell
Vice President
Paladin Associates, Inc.
* Aberdeen Group. Working Too Hard for the Money. August 2007.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/03/24/carpe-diem/
Unfortunately, in-house sourcing organizations are already stretched to the limit leaving numerous untapped opportunities. Many purchasing organizations have cut staff, and further reductions may be underway. There are no budget dollars to hire additional sourcing staff nor to bring in external consultants to reap the benefits these market conditions present.
What is the business justification to address this dilemma? According to Aberdeen*, the average company has only between 51% and 90% of spend under management, and every new dollar brought under management nets a 5-20% cost reduction. Let’s assume your company is better than average with 80% of spend under management. That means 20% of spend is unmanaged. For every $10 million spent on purchased goods and services that leaves $2 million unmanaged. Since every new dollar brought under management nets a 5-20% savings, the $2 million of newly managed spend would deliver $100,000 and $400,000 in savings and bottom line profit! Assuming your company’s profit margin is 20%, you would need to increase revenue by $500,000 to $2 million to realize the same profit improvement. In other words, the opportunity is enormous!
Sourcing-as-as-Service using gain sharing can fill you resource gap with no upfront cost or risk thereby allowing you to seize these cost reduction/profit improvement opportunities. Paladin Associates and others offer this option. Since you need to move quickly, you’ll want to select a firm with seasoned professionals who can “hit the ground running”, and who employ the best processes and the latest technology. You’ll also want an organization with experience across a broad array of categories (both direct and indirect goods and services).
Not getting the support you need? Partner with your CFO. He or she can help you cut through the organization politics and sell the profit potential Sourcing-as-a-Service offers. Carpe diem! Seize the day!
Barb Ardell
Vice President
Paladin Associates, Inc.
* Aberdeen Group. Working Too Hard for the Money. August 2007.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/03/24/carpe-diem/
Contract Wisely
The current economic downturn has transformed a number of industries from sellers’ to buyers’ markets. Corrugated is the poster child. Now is the time to lock in favorable pricing. But be wise as you contract. Those who are short-sighted may suffer the consequences as the market fluctuates, as it inevitably will.
Early last fall, corrugated buyers were lamenting an impending price hike. After acquiring Weyerhaeuser in August, International Paper announced a record high linerboard price hike effective October 1. According to Citi Investment Research analyst Chip Dillon, the increase was justified by July’s containerboard inventories being at their lowest level since 1980. Inventories had been depleted, in part, as a result of production losses attributable to Hurricanes Ike and Gustav which disrupted almost 5% of the nation’s monthly capacity.
How quickly things change! Within the space of a few weeks, large US financial institutions failed, credit dried up, the stock market crashed and demand for corrugated plummeted! Producers couldn’t stay ahead of the decline despite capacity being taken off-line faster than the current hot toy leaves shelves on Black Friday.
Bad news for the corrugated industry was good news for buyers. Weak box demand, reduced export shipments and intense competition from recycled-product drove containerboard mill operating rates to 72% of capacity in December, the lowest monthly level in several decades according to the American Forest and Paper Association. Despite significant capacity reductions from machine and mill shutdowns and extended holiday closings, supply still exceeded demand and linerboard prices tumbled. According to Paper Week, downward price pressure will be constant for at least first half of 2009.
It’s a buyers’ market for corrugated and many other products and services, and the perfect time to lock in favorable pricing! Anyone not under contract should be out in the marketplace using competition to capitalize on the situation. It is tempting in this market to use our leverage to squeeze out the last penny and to negotiate a one-sided contract. Be judicious, however. Many markets are cyclical meaning you may regret extreme actions as the market fluctuates.
Last fall, I talked with a colleague at the end of the second year of a three-year corrugated contract. The company had locked in pricing with semi-annual adjustments based on linerboard price index two months prior. Semi-annual protection seemed like a great advantage in the wake of linerboard prices which had escalated $215 a ton (over 50%) since the fall of 2005. Price protection delayed the negative impact of 2007 and 2008 linerboard increases. However, for my colleague it was now time to adjust prices for the remainder of the contract based on the announced record-high October linerboard index. Who could have anticipated that October’s price would be a peak? Locking in at that point, as the contract required, would leave their company in an extremely uncompetitive position in a hard-hit industry. The supplier, having eaten the linerboard increases for months in the past was not inclined to negotiate.
The lesson here is to anticipate inevitable market fluctuations. There is a tendency to think that prices will always increase. Real estate owners and mortgage lenders made this same mistake. For products with high feedstock costs like corrugated, plastic bottles, etc., neither you nor your suppliers can afford to be out of synch with market pricing for a prolonged period. Semi-annual or longer price protection where feedstock costs are significant leaves both the buyer and supplier at too great a risk. To avoid such risk, one could speculate that the supplier padded the original contract price in anticipation of linerboard increases. If that is the case, the buyer is now locked in at an unnecessarily high base price and a peak linerboard price as the market declines. It couldn’t come at a worse time for their business.
Quarterly or even monthly price protection provides a more moderate approach. There will be increased price volatility for sure, but there will also be substantially less risk to both parties. Yes, get the best price you can during negotiations, squeezing margins to favorable levels. However, you should also recognize that the supplier’s price will likely be more aggressive if you minimize the feedstock risk. Use more frequent price adjustments to maintain favorable margins over the life of the contract while mitigating risk as feedstock prices fluctuate. This approach avoids undue pain for either party.
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/02/23/contract-wisely/
Early last fall, corrugated buyers were lamenting an impending price hike. After acquiring Weyerhaeuser in August, International Paper announced a record high linerboard price hike effective October 1. According to Citi Investment Research analyst Chip Dillon, the increase was justified by July’s containerboard inventories being at their lowest level since 1980. Inventories had been depleted, in part, as a result of production losses attributable to Hurricanes Ike and Gustav which disrupted almost 5% of the nation’s monthly capacity.
How quickly things change! Within the space of a few weeks, large US financial institutions failed, credit dried up, the stock market crashed and demand for corrugated plummeted! Producers couldn’t stay ahead of the decline despite capacity being taken off-line faster than the current hot toy leaves shelves on Black Friday.
Bad news for the corrugated industry was good news for buyers. Weak box demand, reduced export shipments and intense competition from recycled-product drove containerboard mill operating rates to 72% of capacity in December, the lowest monthly level in several decades according to the American Forest and Paper Association. Despite significant capacity reductions from machine and mill shutdowns and extended holiday closings, supply still exceeded demand and linerboard prices tumbled. According to Paper Week, downward price pressure will be constant for at least first half of 2009.
It’s a buyers’ market for corrugated and many other products and services, and the perfect time to lock in favorable pricing! Anyone not under contract should be out in the marketplace using competition to capitalize on the situation. It is tempting in this market to use our leverage to squeeze out the last penny and to negotiate a one-sided contract. Be judicious, however. Many markets are cyclical meaning you may regret extreme actions as the market fluctuates.
Last fall, I talked with a colleague at the end of the second year of a three-year corrugated contract. The company had locked in pricing with semi-annual adjustments based on linerboard price index two months prior. Semi-annual protection seemed like a great advantage in the wake of linerboard prices which had escalated $215 a ton (over 50%) since the fall of 2005. Price protection delayed the negative impact of 2007 and 2008 linerboard increases. However, for my colleague it was now time to adjust prices for the remainder of the contract based on the announced record-high October linerboard index. Who could have anticipated that October’s price would be a peak? Locking in at that point, as the contract required, would leave their company in an extremely uncompetitive position in a hard-hit industry. The supplier, having eaten the linerboard increases for months in the past was not inclined to negotiate.
The lesson here is to anticipate inevitable market fluctuations. There is a tendency to think that prices will always increase. Real estate owners and mortgage lenders made this same mistake. For products with high feedstock costs like corrugated, plastic bottles, etc., neither you nor your suppliers can afford to be out of synch with market pricing for a prolonged period. Semi-annual or longer price protection where feedstock costs are significant leaves both the buyer and supplier at too great a risk. To avoid such risk, one could speculate that the supplier padded the original contract price in anticipation of linerboard increases. If that is the case, the buyer is now locked in at an unnecessarily high base price and a peak linerboard price as the market declines. It couldn’t come at a worse time for their business.
Quarterly or even monthly price protection provides a more moderate approach. There will be increased price volatility for sure, but there will also be substantially less risk to both parties. Yes, get the best price you can during negotiations, squeezing margins to favorable levels. However, you should also recognize that the supplier’s price will likely be more aggressive if you minimize the feedstock risk. Use more frequent price adjustments to maintain favorable margins over the life of the contract while mitigating risk as feedstock prices fluctuate. This approach avoids undue pain for either party.
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/02/23/contract-wisely/
Force Majuere
The current economic situation is challenging sourcing professionals in many ways. Force majeure is one issue that may present new challenges in today’s business environment.
The Yale Law Library describes force majeure as follows:
Force Majeure literally means "greater force". These clauses excuse a party from liability if some unforseen [sic] event beyond the control of that party [emphasis added] prevents it from performing its obligations under the contract. Typically, force majeure clauses cover natural disasters or other "Acts of God", war, or the failure of third parties--such as suppliers and subcontractors--to perform their obligations to the contracting party. It is important to remember that force majeure clauses are intended to excuse a party only if the failure to perform could not be avoided by the exercise of due care by that party.
A sales colleague of mine lost his job recently when a customer invoked force majeure and walked from the contract. The customer’s industry has been hard hit by the economic downturn and they believed that constituted force majeure. The seller chose not to pursue the issue legally.
Might this clause also be applied on the buy side in today’s circumstances? One could easily envision a manufacturer unable to fulfill orders without the short-term credit necessary to purchase raw materials, leaving the buyer scrambling for substitutes without economic recourse. Could a buyer also use this clause to his/her advantage to avoid “take or pay” penalties when demand for a supplier’s product is reduced due to the economic crisis? Applicability would, of course, be dependent on the exact wording of the clause.
Donald Trump recently invoked force majeure to delay loan repayment on a Chicago condo development. “’Would you consider the biggest depression we have had in this country since 1929 to be such an event?’ he asked in an interview, adding, ‘A depression is not within the control of the borrower.’” The lender’s attorneys disagree calling this claim “laughable”. Obviously, there is no clear legal opinion.
My associate, Rob Patton, commented that the situation is not completely unprecedented. “I recall that force majeure was very much in vogue in 1973-74 during the first ‘oil shock’. Many suppliers used it to renege on supply commitments, put buyers on allocations, etc.”
As sourcing professionals strive to manage risk, we must take a broad view and consider the applicability of this common clause to the current economic situation. At the same time, we must recognize that contracts cannot anticipate every eventuality. This means that we must truly understand our strategic suppliers’ situations (including their supply chains). This will help us to take preventive actions where appropriate. However, we must also maintain constructive relationships with these suppliers so that when the unexpected occurs we can negotiate win-win solutions. As Rob Patton points out, “The legal side becomes very academic when you start shutting plants down for lack of supply. At that point who cares who wins legally ten years down the road!”
Have you encountered a claim of force majeure in the current economic downturn? If so, please share your experience with us. Opinions are also welcome.
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/01/21/force-majeure/
The Yale Law Library describes force majeure as follows:
Force Majeure literally means "greater force". These clauses excuse a party from liability if some unforseen [sic] event beyond the control of that party [emphasis added] prevents it from performing its obligations under the contract. Typically, force majeure clauses cover natural disasters or other "Acts of God", war, or the failure of third parties--such as suppliers and subcontractors--to perform their obligations to the contracting party. It is important to remember that force majeure clauses are intended to excuse a party only if the failure to perform could not be avoided by the exercise of due care by that party.
A sales colleague of mine lost his job recently when a customer invoked force majeure and walked from the contract. The customer’s industry has been hard hit by the economic downturn and they believed that constituted force majeure. The seller chose not to pursue the issue legally.
Might this clause also be applied on the buy side in today’s circumstances? One could easily envision a manufacturer unable to fulfill orders without the short-term credit necessary to purchase raw materials, leaving the buyer scrambling for substitutes without economic recourse. Could a buyer also use this clause to his/her advantage to avoid “take or pay” penalties when demand for a supplier’s product is reduced due to the economic crisis? Applicability would, of course, be dependent on the exact wording of the clause.
Donald Trump recently invoked force majeure to delay loan repayment on a Chicago condo development. “’Would you consider the biggest depression we have had in this country since 1929 to be such an event?’ he asked in an interview, adding, ‘A depression is not within the control of the borrower.’” The lender’s attorneys disagree calling this claim “laughable”. Obviously, there is no clear legal opinion.
My associate, Rob Patton, commented that the situation is not completely unprecedented. “I recall that force majeure was very much in vogue in 1973-74 during the first ‘oil shock’. Many suppliers used it to renege on supply commitments, put buyers on allocations, etc.”
As sourcing professionals strive to manage risk, we must take a broad view and consider the applicability of this common clause to the current economic situation. At the same time, we must recognize that contracts cannot anticipate every eventuality. This means that we must truly understand our strategic suppliers’ situations (including their supply chains). This will help us to take preventive actions where appropriate. However, we must also maintain constructive relationships with these suppliers so that when the unexpected occurs we can negotiate win-win solutions. As Rob Patton points out, “The legal side becomes very academic when you start shutting plants down for lack of supply. At that point who cares who wins legally ten years down the road!”
Have you encountered a claim of force majeure in the current economic downturn? If so, please share your experience with us. Opinions are also welcome.
Barb Ardell
Vice President
Paladin Associates, Inc.
Originally posted on E-Sourcing Forum
http://www.esourcingforum.com/archives/2009/01/21/force-majeure/
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