Procurement Service Providers - Better Go Get Your Armor

The market for procurement service providers (PSPs), a sector that includes everything from strategic sourcing consulting to GPO contracts to full blown procurement outsourcing, is shaping up to be quite a battlefield over the next 12-18 months. From personal observations of recent trends I predict there will be spectacular confrontations between the industry's major players as they seek to capture and protect market share, particularly in the eagerly desired upper mid-market segment of companies between $500M and $5B annual sales. And it won’t just be the E-Sourcing Suite Giants and Consulting Firm Goliaths fighting for the business of a customer base considerably more PSP-educated than in the heady pre-B2B bubble days. There will be a myriad of PSP boutiques and GPOs joined in the battle, many of these smaller and more nimble players able to offer flexible and customized solutions at significantly lower cost. To make matters particularly feisty, many of these PSP boutiques will be led onto the field of play by the very same consultants who helped to shape and form the procurement consulting practices of their larger opponents in the late nineties and early 2000’s.

If you are the CFO or CPO of a mid-market company today, you stand to benefit handsomely from the upcoming smackdown in the PSP market. You will be able to categorically demand the highest levels of tangible and lasting value from the various players, large and small, who will parade their wares in front of you over the coming year. You will be able to insist that this value be delivered at the lowest possible cost and with the lowest possible operational risk. Specifically, you will be able to stridently and confidently voice the following demands to the massed ranks of Davids and Goliaths standing in front of you ready to fight for your PSP budget dollars-

DEMAND ONE – I want big cost savings that I can measure

You should demand at least 5-12% savings on direct materials and 15-25% or more on indirect. You should demand that these savings be measurable and budget-impacting based on either lower prices or reduced usage through demand management. Look for PSPs who will guarantee cost savings or offer benefits-funded fee arrangements. Avoid PSPs who mention "process" or "efficiency" savings or who ask to be paid like it’s 1999.

DEMAND TWO – I want a fast ramp-up of the cost savings during the first year

You should demand that at least 80% of annualized cost savings be realizable in the first year. You should ask for specifics about how they will bring forward cost savings and avoid multi-month sourcing projects that take a year or more to throw dollars to the bottom line. Avoid PSPs whose proposals feature pages of “sourcing wave strategies” and “commodity work teams”. Look for PSPs who offer flexible rapid sourcing approaches, incumbent renegotiations and pre-negotiated contracts.

DEMAND THREE – I want suppliers that meet or exceed the service levels of incumbents so that I face minimum resistance from internal department stakeholders

You should demand that whatever techniques are used to create savings, internal departments receive equal or better levels of quality and service. You should demand that any new suppliers selected will sign up for service level guarantees in the areas of quality, delivery lead times, customer service and other key category-specific metrics. Avoid PSPs who talk only about “mandating compliance”. Look for PSPs who talk about how they will work in an integrated fashion with internal stakeholders during the sourcing process.

DEMAND FOUR – In exchange for me providing you with a multi-year spend commitment, I would like some of my savings paid up front in the form of a prebate or signing bonus

Depending upon the categories in scope, you should demand that providers work with suppliers to provide upfront savings in the form of cash prebates on contract signing. This technique, used mainly with pre-negotiated contracts, serves as a compliance enabling tool since such arrangements require the customer to pay back some or all of the prebate if a pre-set spend dollar commitment is not met. Avoid PSPs who won’t consider this. Look for PSPs who will.

DEMAND FIVE – I’d like to pay the minimum possible fees for your services. In fact, where practical, I would like to pay nothing at all

Particularly for indirect categories, paying little or nothing for a PSP’s services is not at all far-fetched. Whether through benefits funded approaches or pre-negotiated contracts you should press on providers’ willingness to dig deep and dramatically reduce your investment requirements. Avoid PSPs who persist with ridiculous seven-figure spend management outsourcing pitches. Look for PSPs who offer procurement savings programs where their revenue models are either supplier-funded (e.g. pre-negotiated contracts) or benefits funded (e.g. sourcing fees based upon savings from an RFP).

The above demands are fair, reasonable and – more importantly – will result in your organization being able to maximize the return on its investment in PSP services. Don’t listen to the whines of those who long for a return to the days of multi-million dollar cost structure-feeding “house accounts”. Listen to your business. Listen to your internal stakeholders. Then seek out those PSPs who fight to win the battles in their market place but who do so with a clear focus on what it will take to be successful – putting their customers’ demands above their own.

Let Me Be Direct

Procurement service providers can create game-changing value for their customers in the current economic climate through high impact sourcing initiatives in both DIRECT and INDIRECT spend areas. Since indirect procurement has been well covered in the blogosphere recently (and one can only keep readers interested for so long about how to design the perfect office supplies core list) I'm going to to focus here on how procurement can not only protect profit margins but create sustainable competitive advantage through world class direct materials sourcing. Whether your customers are in manufacturing, retail, food, or consumer packaged goods these procurement strategies will keep your clients afloat through the perfect economic storm and excellently equipped to maintain a healthy lead over their competition when balmy financial weather returns.

THE DIRECT MATERIALS GAME CHANGING PROCUREMENT INITIATIVE

Increase Gross Margins by developing a supply base that enables an organization to minimize cost and maximize customer service for its most highly demanded products.

Thousands of companies go out of business in recessionary economic environments because their supply chains are unable to deliver the very products that their customers are ready and willing to buy. It turns out that many of these same products are also their most profitable. In good economic times, a poorly performing supply chain like this doesn't present too many obvious problems. If you're selling a billion dollars of product at 20% gross margin you can swan along quite happily feeding an operating expense base of nearly $200 million, leaving millions of customers wanting stuff you've run out of and millions of dollars of stuff they don't want sitting on store shelves or in the warehouse. However, when the downturn hits and your sales nosedive, your 20% gross margin is now trying to satisfy the same operating expense base. Hello negative operating income!

Procurement service providers can help companies maintain positive operating margins in recessionary or slow growth environments by helping them select suppliers that can deliver the lowest total cost inputs to production (or resale merchandise for retailers and distributors) while also supporting the highest levels of customer service for the end products that are in highest demand from customers. Low cost inputs result in a profitable product while high customer service results in an available product. Making a profitable and highly demanded product available is the greatest lever a company has to increase gross margin.

What role can Procurement play in this? First, analyze historical order history by product (making sure to include backorders) and identify the 20% of products comprising the top 80% of customer demand. Then calculate profit contribution for each of these high demand products, where profit contribution is the difference between a product's selling price and its total cost including procurement cost, transportation cost, and any internal manufacturing costs. Now identify the 20% of the high demand products that comprise 80% of total profit contribution. These are your company's most profitable and highly demanded products! If an organization can ensure that these products are always available for their customers to buy, it will be fully realizing maximum potential gross margin for its industry sector.

Procurement's role in helping an organization maximize gross margin should be to facilitate a cross-functional strategic sourcing process that identifies, evaluates and selects suppliers based on their ability to meet exacting criteria for total cost management and customer service. Specifically, Procurement should work with stakeholders in marketing, manufacturing, distribution and other departments to develop weighted, metric-based criteria in areas such as a supplier's capability to strategically source their own raw materials, implement lean manufacturing processes, deploy logistics strategies capable of consistently achieving 99% line item fill rates at their customers' point of sale, and manage indirect operating expenses to maintain financial health while delivering low prices to their customers. The outcome of the strategic sourcing process should be a set of closely integrated supply relationships with a small number of supply partners that between them satisfy the ultimate goal of lowest total cost of ownership and highest customer service for the company's highest demand products.

If you are a service provider with a competency for developing low cost/high service level supply bases, you can ensure that your customers will always enjoy gross margins in the top quartile for their industry. Particularly in recessionary or slow growth periods, a laser-like focus on service levels and availability for high profit/high demand products will guarantee financial health until the recovery is in full swing. And by helping your customers optimize their supply chains today, you will help them remain strides ahead of their competitors long after the recessionary period has ended. By maintaining above average profitability for their industry they will be able to make heavier investments than competitors in all aspects of their business, allowing them to maintain a perpetual competitive advantage.

Who said procurement was all about buying pens and pencils?

Vivian and the Barbarians

"Mr. Lewis and I are going to build ships together, great big ships"
- Pretty Woman, 1990

Flying home recently I was talking with the guy next to me and the subject got around to my company. When I happened to mention that a major market focus for us was private equity his immediate comment was "ah, financial wheeling and dealing, huh?" His reaction was natural since many people today still associate private equity with KKR, LBOs and - yes - Richard Gere's ruthless "buy 'em and scrap 'em" millionaire businessman character Edward Lewis from the movie "Pretty Woman".

The fact is the vast majority of private equity firms in the last 2-3 years have introduced a far more operational aspect to the acquisition, management and eventual sale of the companies in their investment portfolios. Major players like TPG, Blackstone and Carlyle all have all built in-house operations groups with a focus on driving bottom line cost savings in portfolio companies through initiatives such as cross-portfolio leveraged procurement. The realization is that these operationally focused programs will ultimately drive more tangible and sustainable EBITDA increases (you knew I'd pull that term out, didn't you?) than any financial wizardry and sleight of hand manipulation of debt to equity ratios and derivative utilization. Smaller, mid-market PE firms are also making strides by appointing "operations czars" to coordinate cross-portfolio cost savings programs and in many cases hiring PE-focused consulting firms to help plan and manage these programs.

Over the next few weeks I will be featuring guest commentaries from several PE firm operations executives who have been given the responsibility of spearheading various types of cross-portfolio cost reduction initiatives in their organizations. They'll give a fresh take on how more and more PE firms today are driving genuine value creation and leaving firms in a measurably better state post-divestiture than before they acquired them.

I guess it wasn't just Edward that Vivian saved.

Hires That Make You Go Hmmmm....

Lot of banter on the blogs recently about the pros and cons of hiring staff from internal departments to fill positions on indirect procurement teams. Over on Supply Excellence, Justin Fogarty in his piece Category vs Procurement Experience: Which matters more? talks about several presentations he has seen from senior procurement executives who in each case saw "great results by actively recruiting for new procurement headcount from other functional areas of the company". Justin specifically mentions AXA CPO Dr. Heinz Schaeffer and Heinz VP Procurement Chris Stockwell, both of whom achieved significant headcount increases in their organizations by transferring in people from Marketing, IT and other departments.

The most common argument in support of hiring internal stakeholders into procurement is that the new recruits bring deep category expertise and ready-made stakeholder relationships that could only be acquired by hiring directly from the area in question. By providing crash courses in purchasing and contracting practices these individuals will immediately become "uber-buyers" capable of creating value even in "sacred cow" categories. They will mesh their newly acquired sourcing capabilities with pre-existing domain knowledge and work seamlessly with their ex-colleague stakeholders to implement bleeding edge sourcing strategies that simultaneously drive innovation, quality, service and lowest total cost of ownership.

And all this time I thought that building a world class procurement organization and was such hard work! All that search for procurement talent, all that investment in strategic sourcing best practices , and all that relationship building with internal stakeholders. And all I had to do was......HIRE FROM OTHER DEPARTMENTS???? Oh dear, something don't smell right and it ain't the burgers. First of all, are there cases where internal transfers into Procurement have worked out excellently? Of course! Very many. But does that mean it should be utilized as a formal strategy for building a procurement team? Nah, and here's why.... My Top Ten Reasons For NOT Utilizing Internal Transfers as a Formal Strategy for Building World Class Procurement Organizations:

Reason 10. As a formal organization building strategy it won't always be available anyway - hiring from within is almost always driven by budget pressure and the need to shuffle people internally rather than hire from the outside. When times are good again the source of internal hires will dry up.

Reason 9. Internal customers usually leave their departments for a reason. Either because they had no option (as in #10 above) or because they are bored or disenchanted with their current work. They are very unlikely to be people who have "always wanted to be in procurement". Consequently they will not necessarily be enthusiastic about their new role which is something a Chief Procurement Officer would presumably want to be the case.

Reason 8. Closely linked to #10 above, a Chief Procurement Officer needs to be very careful that he/she doesn't set a trend of being prepared to forego hiring from the outside. Regardless of whether it makes sense on some occasions to hire from internal departments, there will come times when the correct decision is most certainly to hire from the outside. If you've convinced yourself and your CEO/CFO that hiring from within can always be the right decision then your chances of bringing on board that stellar external candidate when they become available is very slim.

Reason 7. The influence that internal hires into procurement will have in helping garner stakeholder support from their ex-colleagues is usually overstated. Again, people who leave departments to join procurement will not usually be the movers and shakers and will usually have cast small shadows among their peer groups.

Reason 6. Paradigms and mindsets can be hard to break. In my aerospace industry days we hired an extremely capable design engineer into our sub-assembly procurement group and one of the main reasons he struggled was his tunnel vision about specs and unwillingness to consider new supply sources for critical components. Just one example I know but nevertheless one to bear in mind when beaming someone in to fill a supply management slot.

Reason 5. Crash Training Don't Work. Never Has. Never Will. The thought that you can take an internal customer and over the course of a few weeks "brain helmet" into this person all of the thought capital that has been developed in the field of strategic sourcing and procurement these last 10-15 years is quite frankly insulting to, well, all of those who developed this thought capital.

Reason 4. Bringing someone into procurement to leverage their expertise in one category seems a bit inefficient doesn't it? Top notch sourcing professionals in most best practice procurement organizations are perfectly able to leverage their expertise across several category areas. Even if a company has a very high spend in say, advertising, parachuting someone in from marketing to talek advantage of their media buying expertise will mean that individual will either have to take on other categories as well (negating the stakeholder expertise argument) or you've just tied up a whole FTE on one category.

Reason 3. The hire from within strategy makes the basic assumption that differing viewpoints, disagreements and even a measure of conflict are bad things. I question that assumption. Conflict can be good. It airs opposing points of view. It throws out alternative solutions that can be kicked around and evaluated a bit. One of the highest value adds that procurement brings to the table is to challenge stakeholder specifications and requirements. Not to call them wrong, just to push back a bit, engage in some give and take. By simply rebranding stakeholders as procurement folks we're saying that this particular role holds no value. That's plain wrong.

Reason 2. World class procurement organizations from HP to P&G to Disney have achieved high performing supply management processes by leveraging in an integrated end-to-end fashion the unique capabilities of all stakeholders, including procurement. One of procurement's key roles is orchestrating the interaction of suppliers and various internal customers to maximize service and quality at lowest total cost. If an internal hire truly sees this a role they wish to aspire to through rigorous professional development and job experience in the procurement field then that's wonderful. But again, if it's a Hobson's Choice, then procurement, the individual in question and the whole organization have created negative value.

And now....The Top Reason For NOT Utilizing Internal Transfers as a Formal Strategy for Building World Class Procurement Organizations.....

Reason 1. Building a World Class Procurement Organization that is respected and held in the highest esteem by internal departments is hard work.........BUT ISN'T ANYTHING WORTH HAVING HARD WORK? Don't compromise. If you're a CPO looking to create game-changing bottom line savings for your company then market the business case for a world-class procurement organization to your CEO and then BUILD IT!

Bo Knew

Bo Andersson's departure from GM last Friday may have had more to do with a shortage of what we procurement nerds call "addressable spend" than a shortage of bright ideas. The auto maker's former procurement head would have shouldered much of the responsibility for turning GM into a profitable operation post-Chapter 11 and with fewer tools at his disposal than MacGyver on a bad day Bo may have realized the impossibility of his task. Let's look at the numbers based on GM's 2008 financials and you'll feel Bo's pain:

Firstly, Andersson would have had two spend bases to work with to create the savings necessary to return GM's operating income to positive territory - purchased content in Cost of Goods Sold and indirect spend in SG&A. Let's do some super-rough calcs to figure out how much Bo would have had to work his magic on:

Cost of Goods = $150.6B, so assuming about 70% purchased content this corresponds to a direct materials spend of about $106B

SG&A = $14.2B, and assuming about 70% of the SG&A is indirect spend with only half of this being addressable results in an addressable indirect spend of about $5B

So let's say total spend under Andersson's management would have been in the range of $110B. How much savings could he have theoretically extracted from this total spend base? Well if he did really well and got 8% in direct and 15% in indirect that would be a total savings of $8B in direct and $1B for a total of $9B savings.

Well that's pretty good, right? The $8B savings in direct would wipe out GM's 2008 negative gross profit of $1.4B and contribute greatly towards reducing SG&A (together with non-purchasing savings) and helping achieve at least positive EBITDA if not quite positive net income.

Ah, but wait..... there's just one little matter. In reality Andersson would NOT have had the full $106B of direct materials to work with. Why? Because the restrictions placed on him under the Chapter 11 operating model now agreed between the UAW and the Obama Administration would have prevented Andersson from being able to execute the full range of potential sourcing strategies he would need to capture 8% savings over the complete direct spend base. This operating model requires UAW approval of sourcing decisions that would impact %outsourced assembly, %domestic vs. %off-shore content, and other various criteria. Net net, a whole range of world-class sourcing strategies that would have given Bo a fair shot at delivering game-changing cost savings to GM were stolen from his toolkit.

In reality the genuinely addressable direct spend base that Andersson would have had to work with would have been, oh, maybe 25% of the $106B. I'm just guessing here, and might still be on the high side. This is the part of GM's direct materials spend that for whatever reason has been able to enjoy the benefits of global sourcing, major sub-assembly outsourcing and other best practice supply strategies. And guess what, his ability to extract incremental savings in this spend areas would almost certainly be LESS since, by definition, many best practices are already in place. Realistically he would have achieved a maximum of about 5% further savings on this 25% of the total spend, or only about $1B. Hardly enough to erase GM's 2008 negative gross profit.

If there's a motto here (and of course there is) it's that.....ultimately.....a procurement team can only be as good as the addressable spend they are allowed to have and the levers they are allowed to pull. Otherwise even the world's most talented sourcing and procurement professionals will feel like white water rafters approaching the falls with only teaspoons in their hands for paddles.

Pick Your Battles, My Young Sourcerer!

Andrew Tsang recently started an excellent discussion "Aligning Ad Agency and Procurement Incentives" over on LinkedIn in the Strategic Sourcing & Procurement Group. Andrew proposes that advertising is a high potential area for creating value through strategic sourcing if marketing and procurement could find a way to reconcile their apparently opposing objectives around cost reduction and revenue enhancement. I absolutely agree with Andrew.

Having provided strategic sourcing services to several clients in the marketing category I'd say one of my personal lessons learned is that there are good places and bad places to start when approaching this particular area. For example, striding into the creative area armed with a fistful of RFP templates and value-based SLA metrics is an experience that usually does not end well. One area I have found in my experience to be a sensible starting point, however, is the media buy - particularly print ads in newspapers and magazines. And I'm talking the media BUY, not the planning. Tell a marketing department that you can take their existing media buy plan for the next quarter (down to the geographic markets, specific newspaper vendors, ad specs and quantities) and help them execute that media buy at 15-20% lower cost (this is actually very possible with the state of the ad market today) then you have a chance to deliver an early win that will allow you to build a long term relationship. You haven't challenged marketing's territory around creative strategy or even advertising planning - you've helped them do what they want to do at a lower cost. Now, you may have to play hardball with an incumbent media buying agency or even bring another agency or two into the mix for the client to consider but this is nothing compared to the vertical uphill battle of even suggesting that you may be trying to tinker with the creative process.

Let's Get Critical

Hundreds perhaps thousands of auto suppliers are right now hoping they are going to make it on to GM and Chrysler's list of critical suppliers. These are suppliers deemed by the auto manufacturers as "critical" to their continuing operations as they continue through and eventually exit Chapter 11. Any company entering Chapter 11 is of course provided protection from its creditors. Most of these creditors are suppliers of goods and services, everything from major subassemblies to office supplies. How it usually goes down is that the biggest suppliers who are owed the most dollars are assigned "critical" status and get paid most of their outstanding invoices at the originally presented payment terms. For GM and Chrysler this means the Tier One suppliers. Lower tier suppliers who don't make it on to the the OEM's list of critical suppliers will not be so lucky. Their payment will generally be extended 30 days or more beyond their originally presented terms or in many cases will be told their payment is "pending". The other shoe to drop for these lower tier suppliers is that their lines of credit will immediately be frozen, meaning that they are unable to make payroll or buy parts from their own vendors.

Hmmm. Those supply risk management gurus among you are already sensing where I am going here aren't you? It will not at all surprise this blogger if we hear about supply outages and quality problems in the months ahead from the new, "streamlined" post-Chapter 11 GM and Chrysler organizations. In protecting the "critical list" suppliers it's very likely that many of the lower tier suppliers will themselves have flatlined and left gaps in the auto supplier chain that will need to be backstopped by alternative sources that will take time to identify and qualify. And even then there may be teething problems in quality and service levels as the new lower tier vendors (many of whom I suspect will be offshore) are onboarded.

So as not to seem totally doom and gloom, this can all be managed. But there will need to be a plan. A plan that starts up front with a holistic set of criteria for defining what a "critical" supplier is over and above it's status as a tier one and it's annual revenues from Hoovers. Factors such as a lower tier supplier's impact on upper tier supply chain performance. Secondly a plan for recognizing that many lower tier domestic auto suppliers will unfortunately fail and that there will need to be early and proactive planning for replacing many of these with new (and in many cases offshore ) vendors. This means sourcing new vendors able to meet product and process specifications, and implementing global supply chain strategies capable of delivering required service levels at lowest total cost of ownership.