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.

Are You Crazy? The Stock-Out Will Probably Kill You!

"Jimmy, what's the markup on that Belgian Ale anyway?" Colin Davies, an affable Scot, mischievously inquired of the bartender. Jimmy fake squirmed at the question as he placed a second martini in front of Davies' drinking partner, a weary-looking businessman who had been a frequent visitor to the brew pub this week. Bill Pike, CFO of a locally based supermarket retailer, smiled at the banter between the two men, grateful for a brief respite from his day job woes.

"Not enough obviously" replied Jimmy with a chuckle, tucking Bill's bar tab into a glass in front of him . "I'm still working here aren't I?"

"Anyway it's not like the price puts the punters off" Jimmy continued. "I can't keep it in stock. That why you're drinking Bud - I never run out of that." Jimmy winked conspiratorially at Bill, moving away to tend to another customer.

"You see, it's like I was saying" Colin said, turning to face Bill. "Jimmy's situation's no different to what I see with many of my customers. Even with the economy falling down around their ears I have clients who repeatedly run out of the very products that their customers most want. And on top of that, many of those same products are their most profitable as well. There are literally thousands of companies in the United States today that could go out of business because their supply chains are unable to deliver products that their customers are ready and willing to buy."

"Reminds me of our Operations meeting this past Monday" remarked Bill. "Same store sales down 12% last quarter and we still had stockouts for six of our top ten products."

"Top ten products in what?" asked Colin.

"Well, top ten in sales of course" replied Bill.

"Ah, of course" Colin said in a mock-knowing tone. "Tell me - did you have any stockouts for your top ten most popular and most profitable products as well?"

"Well I don't know. I'm not even sure we know what those are" admitted Bill.

Colin inched his barstool closer to the CFO, looked around and leaned in as if about to impart critical information to a fellow undercover operative. Bill smiled at the Scot's melodramatics but bought in to the role-play, cocking his head slightly toward Colin to receive the incoming intelligence.

"What were your net sales and gross profit last quarter?" Colin asked, almost in a whisper.

"Four hundred million sales" Bill replied. "Gross profit a hundred million, give or take a buck."

"Okay, so 25% gross margin. And you've already told me you made a ten million operating loss so your operating expenses were about $110 million. I can give you some ideas for attacking the operating expenses later, but let's focus on the gross margin first. What if I said you could increase your gross margin from 25% to 30% in six months and generate an additional twenty million dollars in operating income on the same quarterly sales? And what if all you had to do to achieve that was avoid Jimmy's mistake?"

"You mean buy more Belgian Ale?"

"Exactly!" Colin laughed. "In your case it would mean ensuring that your most popular and most profitable products are always on your store shelves for customers to purchase. I guarantee if you achieve this you will be in the top quartile of your industry for gross margin. You'll regain profitability and stay profitable even if your sales were to drop a bit further, too. And one more thing - if you address this by transforming your supply chain today you'll remain several steps ahead of your competitors long after this recession has ended. Your above average profitability for your industry will enable you to make heavier investments than your competitors in all aspects of your business, thereby allowing you to maintain a permanent competitive advantage."

"It sounds so obvious - getting customers the products they need. Why aren't more companies doing this today?" asked Bill.

"I'd say one reason is because when the economy was good a company could hide a poorly performing supply chain with sheer volume throughput of products. 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, all that time leaving millions of customers wanting stuff you've run out of and with millions of dollars of stuff they don't want sitting on store shelves or in the warehouse. The problem comes when the downturn hits, your sales nosedive and your 20% gross margin is now trying to satisfy pretty much the same operating expense base. Hello red ink."

"Okay, so I'm biting. How do I achieve 30% gross margin?". The CFO took a furtive, hurried sip from his cocktail, fidgeting a little on his barstool as the other man continued.

"Well, it's not easy but it is straightforward" the Scot started. "First you ask your merchandise operations group to provide you with a report showing stock turnover and profit contribution for each merchandise stock keeping unit - or "SKU" for short - over the last twelve months. What are those? Well, think of stock turnover for a SKU as the number of times that SKU gets replenished in inventory during a year as a result of customer sales. Quite simply, think of a SKU with a high stock turnover as being in frequent demand. And that's completely irrespective of how much this SKU sells for or how profitable it is. It's just a popular SKU, the lucky chappy.

As for the profit contribution of a SKU, this is equal to the dollar profit that an individual SKU makes to a company's total gross profit. To a first approximation it is simply the difference between the wholesale price your company pays the manufacturer and the retail price paid by the customer in a store. A detailed calculation would take into account several other factors such as volume discounts and process costs but for our purposes the simple definition is perfectly adequate."

Bill paused here to sip on his beer, the CFO regarding him somewhat impatiently. Grimacing obvious disapproval at the blandness of his beverage, the Scot continued.

"Now at this point you will need the services of a management consultant" Colin stated in a serious tone.

"A consultant? Why?" asked Bill, suddenly confused.

"To draw a two by two graph" Colin replied. Poker-faced for a couple of seconds, a teasing grin then broke across his features. "Just joking - you will need to draw a two by two but internal resources should suffice." Bill rolled his eyes at the Scot's witticism.

"Funny. Anyway I was Big 6 consultant myself a few years back. I'm a two by two Subject Matter Expert" Bill jested back. "And like any SME I always bring the right toolkit. Here - have a napkin!" The CFO grabbed a paper napkin from a pile on the bar and proffered it towards his drinking partner who received it gratefully, laughing.

"Funny yourself" said Colin, pulling a pen from his jacket pocket and starting to draw on the napkin. "Okay, so here you go.... this two by two has stock turnover by SKU on the y-axis and profit contribution by SKU on the x-axis. Each axis is simply low/high. Using the report from your merchandise group you plot all the SKUs on this graph - it's the top right quadrant we're most interested in. The SKUs in this quadrant are the most frequently demanded and they are also contributing the greatest amount of dollar profits to gross margin."

Colin then peppered the graph's top right quadrant with about half a dozen rapidly penned crosses, each of them representing data points from the merchandise group's report. He then fenced all the crosses with a heavily drawn circle.

"Read my lips" Colin stated, point of his pen in the center of the circle - "MAXIMIZE LINE ITEM FILL RATE FOR THESE SKU's IN YOUR STORES."

"Line item fill rate?" questioned Bill.

"The line item fill rate for a SKU in your store is the percentage of times over some period - usually a year but it can be any time period, say a quarter - that a customer can walk in and purchase that SKU from your store shelf." Colin replied. "For all the SKU's in the top right quadrant of our two by two here you need the line item fill rate to be a close to 100% as possible. If you do this you will be ensuring that those products that contribute the most dollar profits to your gross margin - and operating income as well - are always available to, well, do just that. By actually being there for a customer to buy."

"This is all sounds so simple" said Bill.

"Well, there are a few devils in the detail like deciding exactly how many SKUs should be in the top right quadrant" replied Colin. "And after that, setting a realistic percentage for the line item fill rate target for each SKU that balances the cost of a stockout against the increased inventory holding costs. Plus there are strategies for the other three quadrants that we should also talk about some time that will lower your overall cost of doing business even further. But conceptually, yes it's simple. It will certainly need some dedicated effort from some of your best and brightest folks in your merchandise operations and inventory management areas but the return will be worth it."

"I agree, and quite frankly I've got nothing to lose. If I can't pull things around this quarter I'm probably history."

"Look at it like this, Bill. This recession may be a positive thing for your company. Today, like most of your retail competitors, you've got an underachieving 25% gross margin supply chain that's served you adequately in good times. Now the recession has exposed your supply chain's limitations and you need a 30% gross margin supply chain to get you out of trouble. Move smartly to put the new supply chain in place and you may never be in trouble again. In fact, if as I suspect you end up being one of the first companies to move on this you will end up being one of your industry's highest performers both financially and operationally on an ongoing basis."

"Well I'm intrigued enough to put this to my COO" said Bill, settling his tab and rising to leave. Perhaps I could even loop you in for a conference call if Sarah wants to dive into any of the detail?"

"Sure, I'd be happy to. You've got my card." Colin replied. He stayed seated, obviously settling in for the long haul. The two men shook hands. Bill turned to leave but stopped suddenly and looked back at the still seated Scot."Colin...you mentioned giving me some ideas about attacking operating expenses as well? I'd be interested in hearing about that as well sometime."

"No problem. Just over a hundred million dollars of operating expenses last quarter, right? That's an even easier area to find rapid savings, even though an English buddy of mine treats it like rocket science. If you're around next week I'll tell you how to get another ten million cost savings out of indirect procurement. Oh, and without any seven-step strategic sourcing methodologies or transition management programs either."

"Excellent" said Bill with a slightly puzzled expression. "Without those. Look forward to it!" Shaking Colin's hand again he turned and exited the bar, decidedly more spring in his step than when he had entered two hours before.

"Hey, Jimmy!" Colin called, dismissively pushing his unfinished Bud away from him. The bartender broke away from conversation with another customer, turning towards the Scot. "When you get a moment, let's discuss supply chain strategy for your Belgian Ale."

I'm Mr. Brightside

CFO walks into a bar, drops tiredly down on a barstool. "Jimmy!" he rasps urgently to the barman, "Get me a gimlet! And get me another while I'm waiting!"

"Tough week?" sympathizes Jimmy as he starts to mix the man's cocktail.

"Tough quarter" the CFO moaned. "The worst. Lost ten million. Next quarter will be even worse. No end to this recession in sight. Could be in Chapter 11 before the end of the year. Where's your roof access Jimmy?"

"Whoah, hold on there fella!" said Jimmy. "Haven't you heard of looking on the bright side?"

"The bright side? How can there possibly be a bright side in all this??" retorted the CFO in wide-eyed dismay.

"Well..." said Jimmy, placing the CFO's cocktail in front of him, "it's funny, but there was this guy in here last night saying how you could keep almost any business profitable by doing only two things. Even in a recession. And in fact, he said, businesses who carry on doing these two things when the recession has ended stay ahead of their competition. Forever. So I said to him that's kind of like a bright side of a recession, isn't it? He laughed and said to me, "I guess it is". "

"Really" drawled the CFO sarcastically, "and what would those two things be?"

"Let me see" said Jimmy, wiping a glass and looking ceilingwards as he worked to recall the man's words from the previous evening, "the first thing was about, um...wait a minute...maximizing high margin life rate and the second was, um, something about realizing rapid indirect fruit...."

"What the...??" said the bewildered CFO, "how much had he been drinking?"

"You can ask him yourself" laughed Jimmy. "He said he'd be in here again on Friday."

Will This Bailout End in Tiers?

Many of you will have learnt from the auto bailout news coverage that GM, Chrysler and Ford between them owe about $10B to their suppliers. You may also have learnt if you did not know already facts such as the following:

-Parts and components provided by auto suppliers (car seats, dashboard consoles, doors, windows, axles, wheels, brakes, etc.) constitute over 70% of the cost of a vehicle rolling off the production line in Detroit.

-While GM, Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers employ more than 600,000 workers

The "so what" about the above two nuggets is that the "auto industry" DOES NOT EQUAL GM + Chrysler + Ford although you would never have thought so from either the news coverage or the way that the recent $17.4B emergency bailout package was doled out. The Big 3 comprise CONSIDERABLY LESS THAN ONE HALF of the auto industry by either of the two measures above. And yet there is absolutely no guarantee that those auto suppliers in the greatest financial distress and/or those that are most critical to the auto industry supply chain will receive one penny of the initial $13.4B to be distributed to GM and Chrysler. Them two's got their own executive salaries and UAW wages to pay first. Auto suppliers will be paid strictly on a "what's left over" basis.

By way of an additional industry insight, I was speaking to a friend of mine who works at one of the auto industry's major tier one suppliers (i.e. one that sells auto assemblies and components directly to one of the Big 3) who told me that of the $10B owed to the auto suppliers over 50% consists of payables that are aged over 90 days. He also told me that many of the industry's lower tier suppliers (those that sell to the tier ones) are facing payment terms of net 120 days or worse (payment term lengths magnify as you go further down the supply chain). In other words they just don't get paid. It's not surprising then that hundreds of these lower tier suppliers have either gone out of business or will be out of business in the early part of 2009. To make matters worse many of these suppliers produce critical parts and/or tooling that could bring the entire auto supply chain to a halt if they are delivered late (or worse, not delivered at all) to a tier one vendor.

Okay so I'm being long winded again, what is my point here? My point is that surely there should be some type of strategy in place to guide the bailout funds to those parts of the auto industry supply chain that are most critical to driving higher levels of financial and operating performance for the industry as a whole. Sure, a substantial part of this should go to GM and Chrysler. But from my argument above, less than half. When President Elect Obama takes office he should form a Bailout Funds Distribution Team of auto industry experts to define a financial rescue package that ensures money is distributed among the Big 3, key tier one suppliers and supply chain-critical lower tier suppliers in a way that positively impacts holistic demand/supply chain performance metrics. Leave the distribution of bailout money up to the executive suites of GM and Chrysler and with what's left for auto suppliers you'd be lucky to be able to afford a year's subscription to the Jelly of the Month club.

A Lesson in Sourcing from Hugh Grant

Last night I was watching one of my favorite holiday season movies "Love Actually" and was watching the part where Hugh Grant (playing the British Prime Minister) is giving a press conference following meetings with the U.S. President (played excellently by Billy Bob Thornton). In these meetings the President has said that he will give the Prime Minister anything he wants unless "it is something he doesn't want to give". In the press conference Grant's character calls the President on his bullying tactics saying that the formerly special relationship between their countries has become a bad relationship for Britain. From now on the Prime Minister will make his own demands clear and stand firm on issues that are important to Britain. Go Hugh!

I was reminded while watching this scene of my time as a procurement practitioner in one particular company when I was often invited by user departments to provide assistance with sourcing activities. My relationship with this department was considered "special" from the department's point of view so long as my involvement was limited to providing general guidance on procurement best practices such as RFP procedures, contract templates and the like. On those occasions, however, where I challenged the rationale behind a supplier selection decision (especially when it involved an incumbent vendor) it was made clear that I was going outside of my area of responsibility. So, in effect, the relationship with procurement was only special from the department's point of view if I did not ask for something that they would not give.

What had happened in this instance was that the relationship was not "special" at all but had become a bad relationship for everyone - the user department, procurement, and the company. The user department was making supplier selection decisions based on entrenched histories with certain suppliers rather than an objective evaluation of total cost of ownership. Procurement (in this case, me) was not being assertive enough in challenging user departments with data-driven arguments for considering alternative supply options. And the company was suffering from the relationship because ultimately there were sourcing decisions being made that were not necessarily in the best interests of the organization or its shareholders.

So if you are a procurement practitioner facing the same issues I did how can you turn the relationship you have with your user departments from bad to truly special? Take a leaf out of Hugh's book and hold a press conference. Step out into the spotlight and tell your user departments and your company's senior management that the relationship you have with your internal customers is currently dysfunctional. Tell them that for your company to realize maximum value from its supply relationships there must be open and honest evaluations and communications about the relative merits of alternative vendors. There must be crucial conversations about whether incumbents still offer the most compelling value propositions for total cost of ownership, quality, service and supply risk. There must be a global recognition among internal customers, procurement, senior management and suppliers that the correct sourcing decision is not necessarily the most popular.

For sourcing insights that can be gleaned from "National Lampoon's Christmas Vacation", stay tuned for my next post.

e-RFx: It's Not Just About the TCO

The most generally accepted value proposition for e-RFx solutions (whether reverse auction, optimization, or online RFP) is their ability to rapidly and effectively drive lowest total cost sourcing decisions through whizz-bangs such as “competition-inducing online bidding environments”, “optimization tools facilitating real-time multi-attribute evaluation”, or one of my personal favorites “a geography-negating virtual collaboration medium where buyers and suppliers can participatively create value-maximizing supply solutions”. Phew, I’d buy it.

The above is all true of course; e-RFx solutions really do help procurement organizations identify and implement lower TCO sourcing strategies than they could before and in less time. One of the oft-overlooked additional advantages of e-RFx technology however is that it also supports the implementation and consistent use of a single, consistent, best practice strategic sourcing process. As an example I have been working recently with a company that decided to transform its procurement department from a tactically focused buying function to a best-in-class strategic sourcing organization. One of the problems that this customer faced was that the quality of the contracts developed by its procurement department varied tremendously depending upon who was doing the contracting. This was because each buyer followed a different sourcing process. One buyer would gather detailed usage and requirements information, develop a structured RFP document, and then follow a formal process to issue the RFP, evaluate responses and make the contract award. Another buyer, for the same or a similar commodity, would follow a far more informal process involving only very rudimentary requirements gathering, issuance of a short bid document to suppliers via email, and a rapid award of business to the successful vendor. The point is not that either sourcing approach is necessarily wrong but that there had been no attempt at this company to define and implement a single process that was agreed to be the best practice sourcing method for that commodity.

The beauty of today’s leading e-RFx tools is that they provide functionality that effectively guides (one could even whisper softly “force”) the buyer through each step of a sourcing process that has been pre-defined as being “best practice” for that commodity. So for a price focused commodity like office supplies a leading e-RFx tool will “guide” the buyer through a sequence of steps including completion of a requirements template that provides suppliers with key data such as projected usage and delivery locations, execution of a reverse auction to set core list prices and off-core discounts, collection of key supplier information, and post-auction evaluation of price and non-price factors. For a more complex commodity such as print, the set of steps could include optimizing the award of business by print sub-category to take into account the fact that one printer can be more cost effective in certain types of print processes than another. For an organization that currently has fragmented and inconsistent approaches to sourcing, e-RFx tools provide an excellent way to define and formalize standard processes for these and other types of commodities.

Of course, e-RFx technology alone will not drive the creation of best-in-class contract and supplier relationships. In many cases there will also need to be a step change increase in buyer skills sets to enable effective management of the underlying sourcing process. That being said, I would recommend that any organization currently seeking to implement strategic sourcing best practices consider the role that today’s e-RFX tools (and also e-RFx’s “sister” e-tools of spend analysis, e-procurement and contract management) can play in helping to support the roll-out and consistent use of a standardized, high quality procurement process. Don’t get me wrong, TCO is clearly king when it comes to the business case for these tools. But the comfort of knowing that everyone in the company responsible for making major supply decisions is using the same high quality process is surely a BIG bonus. Remember...as dear ole Ted Turner would say, or sort of....."Early to bed, early to rise, work like hell and standardize!"