Month: November 2019

This is part two of a two-part post on risk and value mapping.  In part one, we provided some historical perspective on how procurement has evolved over the past century and how value-based procurement has become increasingly important.  In part two we discuss the mechanics of applying risk and value mapping and how it relates to supplier relationship management.

Risk and Value Mapping

One of the primary tools – and a great place to start in moving your company into greater value-based procurement – is risk and value mapping your purchases.

The first question we need to explore when doing this type of effort is to look at our purchases and ask a series of structured questions:

• How much do we buy of this item, both in terms of quantity and total annual spend?
• What is the unit cost? The total landed cost?
• How critical is this item to the customer experience? How critical is it to the operation of the enterprise?
• How many suppliers are there for this item? How available is it in the marketplace?

We use the answers to these questions to define the nature of our relationship with the vendors of these items.  First, we need to rank each on the ubiquitous 2×2 matrix – this time one that ranks annual expense of the item on the X-Axis, and the risk or impact of the item on the Y-Axis.

As we rank each item we are, in effect, defining how we will address that item, and potentially its supplier, and our organization’s relationship with them.

Those items that represent the lowest risk and values to the organization and are sourced from simple commodity-type markets will retain a transactional focus.  Here our effort will continue to be to reduce cost, both in terms of item total landed cost and transactional cost.  The more the procurement team can reduce the total cost of ownership for these, the better. As a result, Items in this item quadrant will have short-term contracts to allow buyers to switch sourcing options frequently. These suppliers also have minimal involvement with the business in terms of design, item specification or planning.

At the other end of the spectrum, there are those items that have a significant impact on the organization and its products/services.  These are items that may have direct effect on the customer experience or that have few substitutes and limited supply in the market.  They can be items that are unique to, or differentiate, your products or may represent a highly complex market segment.

As you might expect, the supplier relationship with these vendors is considerably different.  These represent goods and services that have a significant, potentially vital, impact on the business.  As a result, we want to create long-term relationships and contracts with these suppliers and include them in design and strategy considerations.  In fact, the more strategic the supplier the more we should treat them like partners rather than vendors. It may even be wise in some cases to co-invest in these.  We want to ensure that they see our organization as a “Keystone Client”, the one they have the strongest symbiotic relationship with, the one that gets service before the rest.

A part of that, of course, is to understand the potential strategic supplier’s relationship with the rest of the market.  Are they also servicing our competitors? Will they properly protect our intellectual property (IP)? Will they continue to see us as their keystone client in the future?

Using Risk and Vallue Mapping

Our next step is to begin to look at the 2×2 matrix, the Risk and Value Map, first in broad terms and then, more specifically, how we should handle the goods and services that lie in each quadrant.

In our first step, we can quickly see that the products fall into three general categories:

1. Low risk items, irrespective of the annual volume, tend to be generic or commodity-type items.  They are simple orders that can be generally acquired from several different suppliers, so long as the form, fit and function remains the same.
2. High Risk/ High Spend items, the upper right quadrant, are items that define our competitive advantage.  These are items that have a significant impact on the customer experience, that are unique applications of IP, or that are singles sourced due to technology or resources.
3. Finally, there are the potential problems, the upper left quadrant.  These are items that are high risk, but we spend too little on to have enough leverage or control with our suppliers to protect our firm in the event of disruption or competition.

Now let’s look at how we should handle the goods and services that fall within each quadrant

Tactical Spend

These purchases are characterized by high transactional cost relative to the item unit price. For example, a box of 100 U Drive Screws, 1/4 In , #4, Stainless Steel costs $9.22 at Grainger Industrial Supply, but let’s say your Procure-to-Pay cycle cost to buy and stock it is $92, then the transactional cost is about 1000% of the purchase price.  Clearly, the focus for items in this category should be on minimizing the transactional cost associated with the item.  To do this, we apply two broad strategies:

1. Streamline Procurement Process
   1. Use eProcurement / eCatalogs
   1. Use Procurement Cards (Pcards)
   1. Use EDI for both the procure and pay cycles
2. Minimize number of transactions
   1. Optimize inventory order policy
   1. Leverage vendor managed inventory (VMI) and consigned inventory

Further, we need to view these products as commodities and therefore minimize time spent communicating with the supplier. After all, these are low volume goods we can get from several suppliers.  For that reason, we want to also keep our vendor contracts for these items as short as possible, allowing the freedom to move quickly and often in order to take advantage of price changes in the market.

Leveraged Spend

The Leveraged Spend Quadrant represents those low unit price items that we buy in such quantity that they account for a large spend in aggregate. For this group, the key components of our procurement strategy should be:

1. Streamline the procurement process
   1. Utilize reverse auctions, allowing the suppliers to compete between themselves for your business
   2. Sealed Bid/First Price auctions.  This is the standard request for quote (RFQ)/request for proposal (RFP) approach
2. Leverage purchasing volume
   1. Consolidate orders across divisions and business units to maximize purchasing volume
   2. Add volume for vendor with Combinatorial Contracts.  These are contracts where you include additional products in the quote process to allow the supplier not only economies of scale but also economies of scope
   3. Utilize Industry Portals and/or group purchasing organizations (GPOs). These allow multiple companies within an industrial vertical to consolidate their orders, again with the goal of getting volume discounts
3. Utilize Spot markets to ensure business continuity. As commodity items, multiple vendors are available. In the event of a shortage from your key supplier(s), don’t hesitate to utilize spot markets to ensure that the needs of the business are met.

In this quadrant our goal is to minimize not just the unit price, but the total landed cost (TLC). And how we do that is, in many ways, like what we do in the Tactical Quadrant:

• Be prepared to change vendors based on TLC
• Continuously be on the lookout for new suppliers
• Keep contracts as short and flexible as possible

Strategic Spend

The Strategic Quadrant represents those high volume/high spend items that give you a competitive advantage and/or have a direct impact on the customer experience. Failure in this area of the supply chain can have a long-lasting impact on the brand or the enterprise, and therefore the associated suppliers and supplier relationships need to be carefully cultivated and maintained. Consequently, the Strategic Quadrant has a very collaborative focus. This may incorporate various elements of supplier partnership including:

• Long-term Contracts
• Partnership Agreements
• Co-development of Products and Innovation
• Potential Co-investment

To further mitigate risk, you should also consider what other clients these suppliers serve.  Do they work for your competitors, too? Also, in this quadrant, it may make sense to consider vertical integration, whether actual or virtual (i.e., contractual).  Vertical integration can help reduce risk of supply chain interruption, protect sensitive intellectual property, and provide additional sources of revenue.

Here are a couple of other key take-aways on strategic spend.  First, DO NOT use eProcurement for strategic items.  The usefulness in eProcurement is in its ability to streamline the purchase of routine, low unit cost items to reduce the transactional cost and minimize time spent interacting with the supplier.  Since strategic items basically represent the antithesis of that model, we want to stay away from eProcurement for these items.  Instead, we want to stay in close contact with these suppliers about their shipments of goods and services.  Remember, this is the collaborative quadrant, so pick up the phone and coordinate with your strategic suppliers.

Second, while collaboration is the key here, don’t get so wrapped up in your suppliers that you lose sight of what is best for your company. Focus on strategic supplier collaboration, but ALWAYS protect the enterprise first. And you do this, in part, by building resilience through cultivating at least one alternate supplier where possible, be on the lookout for substitute parts, and optimize safety stock levels for critical items at a risk-appropriate level.

Critical Spend

The final area, the Critical Quadrant, is what should keep you awake at night. These items are where nightmares come from.

You should have one goal with items that lie in the Critical Quadrant – move them to another quadrant. Any other quadrant.  As quickly as possible. These are goods and services that put your organization at risk and at liability.

How and where do you move them? Each item will need to be evaluated separately, but here are some general options.

Move to the Tactical Quadrant. In order to make these items tactical consider looking for more suppliers, thus making them more commoditized.  This may require changing engineering specifications to allow standardization with other, more common parts. Also, you may find that the item’s function can be performed just as well from the customer’s point of view using a less complex part or parts.

Move to the Leverage Quadrant. To make the transition to a leverage part, may again require reviewing engineering specifications to identify ways to simplify the item, making it more widely available. You may also find that the part is used elsewhere in your enterprise.  By consolidating purchases across your organization, you may be able to identify enough total volume to move the item into a leverage buy. And if not, you may be able to consolidate purchases with other businesses – notably NOT to include any direct or indirect competitors – or through an industry-specific GPO to achieve that volume.

Move to the Strategic Quadrant. If the item is identified directly with your company or brand, or if it has a direct impact on your customer’s experience of your products or services, or if it’s complexity cannot be reduced, you must move this item to the Strategic Quadrant.  In fact, if any of the above criteria hold, these items should be your first priority because they represent the most immediate and significant threat to the organization or brand. These are items at known risk that are vital to your product. Don’t delay.

To move these items, you may want to include them in existing contracts with your strategic suppliers to ensure the part’s availability while strengthening that vendor relationship. Alternately, if the item must stay with the current supplier you may need to partner with that supplier. This can be done in several ways.  The quickest is often to agree to pay more per unit or to enter into a long-term contract with a sole-source vendor to ensure availability and the supplier, in turn, agrees to maintain a stock of the items and/or the materials to continue building the item should a disruption occur. You may also want to explore other ways of partnering with this supplier to form some degree of vertical integration, whether actual or virtual. However you go about it, though, moving items to the Strategic Quadrant is likely to incur additional costs, either through higher unit prices, loss of flexibility in future sourcing, or investment in partnering with the supplier.

Digitization

No matter what quadrant you are dealing with, however, it is important to be utilizing the digital tools in your Procure-to-Pay (P2P) toolbox. Each of these, when properly configured and deployed, can reduce transactional cost while increasing operational speed.

Tools like advanced shipment notices (ASNs), Supplier Self-Service portals, Electronic Invoicing and Electronic Payments cost relatively little to implement, reduce both errors and touch labor, and therefore, tend to be “low hanging fruit” that generate quick return on investment (ROI).

In fact, PYMNTS.com[i] recently noted:

• 94% of successful supply chain digitization projects directly led to an increase in revenue.
• Return on investment (ROI) of supply chain digitization initiatives is a top motivator for corporates, with 77% citing cost savings as their top driver for a project.
• Other motivating factors include increased revenues (56%) and the emergence of new business models (53%).

But when planning your supply chain digitization program, it is important to remember that thorough knowledge and a solid roadmap are essential for an organization to avoid a poorly selected starting point or a failed deployment that can destroy momentum and discourage leadership from further investments.

Conclusion

The importance and function of Procurement have evolved over the past century. In today’s environment, a focus not only on price but even more on value is critical to the enterprise to ensure not only its profitability but its survivability. For these reasons, the ability to identify, map, and address the risk and value of materials is a critical skill for the procurement professional. Along with risk and value mapping skills, the digitization of the P2P process reduces cost, increases revenue and encourages new business models.

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[i] PYMNTS.com, “Corporations Stuck in The Planning Phase of Supply Chain Digitization”, Dec. 12, 2018

Risk and value mapping

This is part one of a two-part post on risk and value mapping.  In part one, we provide some historical perspective on how procurement has evolved over the past century and how value-based procurement has become increasingly important.  In part two we discuss the mechanics of applying risk and value mapping and how it relates to supplier relationship management.

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Risk and value mapping –

Then and Now: A Brief History of Procurement

Today we are going to briefly discuss the idea of risk and value mapping, what it is, how it works in procurement, and how it helps protect your organization. But in order to really get a sense of context, let’s start by looking back at the evolution of procurement in modern business and how its role in the organization has evolved.

If we were to step back in time about 90 years ago and find ourselves in Dearborn, Michigan, we would likely see a scene like this.

This is the Ford Motor Company River Rouge Complex. “The Rouge” as it was called, was huge by any standard. It occupies a massive 1.5 square mile footprint along the banks of the River Rouge. And within the complex lie ore docks, sixteen million square feet of manufacturing floor across 93 buildings, and 100 miles of train tracks with 16 locomotives. There were steel furnaces, coke ovens, rolling mills, glass furnaces, and plate-glass rollers. There was a tire manufacturing plant, a stamping plant, an engine casting plant, a transmission plant, a radiator plant, and a tool and die plant. And, oh by the way, they assembled cars here, too.

But there wasn’t much of a procurement operation here.  Why? Because Ford owned virtually EVERYTHING.  The Rouge was one of the most vertically integrated operations of all time.  Ford owned everything from the raw material production – such as ore mining – through final assembly and sales. There was very little bought from outside. Consequently, the procurement operation added very little value to Ford in those days.

But times change and with them how markets work. While vertical integration provides a company ultimate control over its material suppliers, there are drawbacks. Here are two obvious ones. First, it is expensive.  Second, it induces brittleness in the supply chain.

It takes a lot of time and money to be great in one industry, be it automobile, glass, plastics, or steel manufacturing. This fact is exacerbated by the complexity of today’s products. Compare Henry Ford’s Model T to even the simplest car rolling off today’s production line.  I imagine there are more components in a car’s cruise control than there were in the entire Model T. And this complexity brings with it greater barriers to entry at each level of a company’s supply chain.  

Then there is the lack of flexibility.  If a company owns its source of supply in any given area, it is unlikely to have a substantial relationship with alternative suppliers.  That means, when a disruption occurs within a company-owned supply chain, there is little opportunity for mitigation beyond their stockpile.

Henry Ford even saw this in 1927. The one raw material he did not control was rubber.  That was produced in Southeast Asia and managed exclusively by British agents. So, Ford bought a huge swath of land in the Brazilian Amazon to build his own rubber plantation. The effort, however, was a colossal failure costing Ford a fortune and many workers their lives. Ford, in the end, was forced to return to the British rubber agents.

Over time, most businesses have moved further and further away from the vertical integration model and adopted a much more nimble, flexible and less asset-intensive approach – “We do what we do best and buy the rest.”

And with this change, the locus of cost to the operation moved steadily from wages, salaries and overhead toward goods and services expense. And just as early automation was an attempt to minimize the cost of labor per unit of production, this transition brought with it attention on reducing the cost of materials and services purchased.

This was the birth of Procurement as a critical business function.

And it is a critical function. In their book “The LIVING Supply Chain”[i], Handfield and Linton describe a concept the biologist Sean Carroll termed Serengeti Rule 1. “(S)ome species exert effects on the stability and diversity of their community that are disproportionate to their numbers or biomass. These are termed ‘keystone species’”.  Applying this definition to the departments within an organization, we can certainly say that Procurement is a keystone department.  Let me illustrate.

In the example above we are looking at a hypothetical company with $500M in annual revenue. The Baseline column shows its current fiscal performance. Each column to the right shows what happens when the cost of goods and services procured is reduced in 5% increments.  All other expenses remain the same.  As you can see, each 5% step down in cost results in about 11 ½% increase in Net Income Before Taxes in this example. Clearly, this is a case where a department exerts a disproportionate effect on the performance of the enterprise.

And therefore, we have traditionally pushed Procurement organizations to reduce costs, reduce costs, reduce costs!

But there are a lot of other factors that remain unseen, hidden under the waterline of the “Price Iceberg”. Factors like delivery performance, quality of material handling, production delays, inspection costs, pre- and post-sales service and support, product training, supplier financial health, and a host of other risks and opportunities.

While the impact of price negotiation is immediately apparent on the bottom line, focusing exclusively on price often leaves other potential risks and values on the table, unaddressed. There are many other questions we need to be asking beyond, “What is the total landed cost of this item?”.  Questions like:

• What other assets/capabilities the supplier can offer in addition to the product/service procured?
• Is the supplier better with existing activities (e.g., inventory management; after sales support; product development…)?
• Can the supplier decrease our risk (e.g., reducing bottlenecks/critical parts purchasing; disruption response; exchange rates)?
• Can the supplier provide some other competitive advantage (e.g., differentiating factor; new product variant)?
• Can the supplier help expand the product portfolio to address new customer needs?

With value-based sourcing, you seek not only to leverage price, but to leverage the skills and assets of your suppliers to develop and expand competitive advantage in the marketplace. This means at times you may pay a somewhat greater per unit total landed cost in order to reap a larger value for your organization.

In shifting from a solely price-based focus to a value-based one, we need to take into consideration not only the total cost of ownership (TCO), but the additional value provided by the supplier. But this requires a bit of a shift in viewpoint and the broadening of a couple of skillsets. The procurement group needs to maintain as lean a purchasing process as possible for low-value items while developing a strategic perspective, both with internal customers and suppliers, to understand where supplier assets and skills can be leveraged to the organization’s advantage.

Value-based sourcing also means that cross-industry benchmarks have a different purpose.  Instead of seeking to be as good as the benchmarks, with value-based procurement we seek to be better.  Better and different through using the value the suppliers bring to the table. This is done, in part, by moving the purchasing position in the organization from one of tactical and operational specification and delivery to one of strategically coordinating vendor resources and assets to meet the business’ goals. This requires the procurement professional to expand his or her skills to encompass greater general business and finance competencies.

Finally, value-based procurement lends itself to a center-led format. In this particular model, the central procurement organization coordinates enterprise-wide, strategic procurement in direct coordination with the business unit level purchasing organizations which, in turn, provides tactical and operational support to the individual operating units and stakeholders.

Next week in part two of this series we will look at the mechanics of risk and value mapping as well as how you can use risk and value mapping to guide your supplier relationship management strategy.

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[i] Robert Handfield & Tom Linton, “The LIVING Supply Chain”, Wiley, 2017, pg. 11