In this seventh edition of Gunpowder, our blogger-in-residence Jason
Busch, tackles a heady but scary topic—the impact that potential
in Iran might have on the procurement world. Jason argues
that Iran is an issue that all procurement and financial executives
need to be thinking about. Next and on a lighter note, Lisa Reisman
takes her pen out to analyze what makes the middle
market different when it comes to direct materials sourcing.
Last, our European voice, Stuart Burns, tells us how to best approach
tricky incumbent supplier negotiations
whether you’re across the pond or in the bucolic industrial
heartland. Read on, and let us know what you think!
Disagree with us or got an idea for an article?
Let us know: email@example.com.
Start Buying the
Canned Goods and Bottled Water?
The more I analyze the situation in Iran, the more
I think that it's going to be the most important Spend Management
issue in 2006. That's because we're not just talking about the
potential for a relatively isolated conflict that will be over
in a matter of weeks or months. Any military action in the region
could set off a number of lasting aftershocks whose economic consequences
are vast and global in nature (especially given Iran's supply
relationships with China and Russia). But regardless of whether
you're a conspiracy theorist or not, it's important to pay attention
to the subject. In my view, operations, procurement, and supply
chain leaders can do this by developing answers to the following
types of questions in the coming weeks to better prepare for a
clash (either military, economic, or both) that is looking more
probable as every day goes by:
- How can we design—or redesign—our overall procurement
goals, objectives, and incentives in 2006 based on cost avoidance
(e.g., by hedging prices, making the investment to develop alternative
sources of supply, etc.)?
- Have our Low Cost Country Sourcing (LCCS) initiatives made
us more vulnerable to supply disruptions? What investments should
we make to mitigate and manage global supply risk?
- How dependent is our supply chain on Near East, Middle East,
and Far East trading partners? What types of shipment delays,
price fluctuations, and other types of supply risk are we willing
to take on?
- How dependent is our organization on petroleum, petroleum
byproducts, and related categories (etc. foam, plastic resin,
etc.)? What financial instruments and other activities can help
us manage downside financial risk? Who are we working with (e.g.,
trading companies, consultants, investment banks) to advise
us to make smart hedging decisions?
- Along similar lines, for larger organizations, how integrated
are our trading and procurement functions?
- Have we quantified the cost of supply disruptions to specific
categories? Should we change/increase buffer stock requirements
and /or modify lean initiatives and other programs to reduce
risk should disruptions occur?
- How can we take advantage of the military's—and related
private sector's—needs for global re-supply and re-building
by developing a flexible Spend Management program that provides
competitive advantage on the sales front for our organization?
- What systems—not IT systems!—do we have in place
to monitor news events and price fluctuations as they occur?
Who is interpreting and analyzing this information for us?
- Are there any technology specific or related investments that
we can make in the near-term to better manage supply risk?
- Does our procurement and supply chain organization have enough
clout in the boardroom to proactively request funds and resources
to proactively take action?
This list is just a start. While I'm not advocating that procurement
organizations stock up on the metaphorical equivalent of canned
goods and bottled water just yet, I believe that paying a bit
more attention on a daily basis to the Iranian situation is a
In his spare time between running a boutique
consultancy and advising Aptium Global, Jason
writes the acclaimed Spend Management blog: www.spendmatters.com
Our Take: Analyzing
on Middle Market Sourcing
This is the first in a series of essays that I'll be writing
on the state of Spend Management in the middle market. Since "middle
market" is one of those loosely defined phrases, we’ll
take a moment to plug in our simplified definition based on sales
revenues. Upper Middle Market firms have revenues from $500m–$1b.
Middle Market firms have revenues of $251m–$499m and Lower
Middle Market firms have revenues of $10–250m. But numbers
alone are boring. Perhaps what is most exciting about the Middle
Market these days is the fact that everyone seems to have taken
notice. When it comes to Spend Management, I believe that there
are huge opportunities in the Middle Market for vendors, analysts,
consultants and most important, Middle Market companies!
For example, Aberdeen Group just published a report titled Strategic
Sourcing in the Mid-Market Boom: The Echo Boom in Supply Management.
I believe that it is a solid analysis of the state of the Middle
Market. Aberdeen hits the mark when they discuss the reasons why
companies deploy sourcing programs and the hindrances to adoption
and success. Aberdeen also strikes gold when they talk about the
lack of formal sourcing procedures in the Middle Market, the lack
of specific commodity skills, the insufficient systems and the
various approaches Best In Class companies have taken to improve
their sourcing success.
Enough praise. I still take issue with a few areas the study
overlooks. What the analysis does not take into consideration
are the nuances of direct materials sourcing practices across
the range of "Middle Market" companies. Lower Middle
Market firms, for example, look and feel very different from their
Middle Market and Upper Market brethren. How are they different?
Well for one, purchasing or using sourcing "systems"
is probably priority 847 on their list of strategic initiatives.
These companies are busy handling day to day purchasing transactions
and while "systems" would be a nice to have, deep sourcing
know-how and commodity expertise are more sorely needed. The complexity
of the part data is also much simpler by comparison. Where an
Upper Middle Market company may need to conduct a spend analysis
for tens or hundreds of thousands of part line items across multiple
disparate systems, Lower Middle Market firms may only have 10,000-20,000
part line items coming from one or possibly two systems (in some
cases, "system" is an exaggeration—the data might
come from a rusting old AS-400 box behind an ashtray in the smoking
In other words, it's often times easier to gather data from smaller
organizations, but virtually all lack the skills, procedures and
sourcing sophistication of larger middle market firms. "Putting
out fires" is a way of life for most small and Lower Middle
Market companies. In fact, one company that I have worked with
processed 32 purchase orders a day with only 1 FTE. You can be
sure this firm is not conducting regular spend analyses, applying
an 80/20 rule to categories to strategically source or even using
basic eRFX or reverse auction capability.
Speaking of reverse auctions, I have found that many Lower Middle
Market firms are hostile to the notion. And I don't entirely understand
why. Most Lower Middle Market firms still have tremendous savings
opportunity because they have rarely introduced any competition
into the sourcing process in the past. I'd say that in 90% of
cases, their incumbent suppliers are taking advantage of their
ignorance when it comes to benchmark pricing. This is a shame,
because it has been my observation that Lower Middle Market firms
typically have anywhere from 3-5 categories that are large enough
to source using competitive negotiation technology (e.g., reverse
auctions, optimization, etc.). Perhaps the greatest irony is that
Lower Middle Market firms are only now beginning to take advantage
of these approaches, despite the fact that their customers, Fortune
500 firms, have been requiring them to participate for years.
And don't ever tell me that small organizations can't use reverse
auctions. I've personally run reverse auctions for a $5 million
industrial company with great results, and received little or
no push back from their suppliers.
It's my view that the majority of Middle Market firms are still
in the womb when it comes to procurement. In other words, there's
an entire world of opportunity out there. The good news is that
a few early adopters are beginning to realize results. And with
Aberdeen covering the middle market opportunity, company interest
will only increase. But a few third-party analyst reports can't
hit on all the nuances of the area. As I've seen first hand, sourcing
in the Middle Market is a different animal all together. In future
essays, I’ll continue to discuss why.
Lisa Reisman is
Managing Director of Aptium
Global where she leads the firm’s practice in North
TWe find in the majority of our projects for industrial companies
with less than $50 million in revenue, customers tell us that
they’re perfectly happy with the quality and service levels
of their incumbent suppliers. But at the same time, they’re
desperate for direct materials cost reduction. Often their secret
hope is that we can wave a magic wand and reduce their incumbent
supplier’s prices by 20% without the need to even consider
Unfortunately it is rarely that simple—or desirable, for
that matter. And when the incumbent supplier is in a monopoly
position or is the provider of a unique product range, it is even
more challenging to achieve savings. While the traditional favoured
approach in this case is to engage the supplier in joint cost
take-out programs, it is our experience that this rarely results
in breakthrough savings. Even if an organization benchmarks its
current prices with those of competitors, incumbents are often
adept at arguing the merits of their product over others, putting
procurement organizations engaged in cost take-out negotiations
at a disadvantage. Smart suppliers often realize that if the buyer
had other viable options on the table, they would not be engaged
in this type of process in the first place.
The good news is that there are a range of tactics that can encourage
even well entrenched incumbent suppliers to reduce costs. And
the process itself often exposes the buying organization to additional
options and suppliers, which they might not have considered in
the past. Based on our experience, it is extremely rare that an
incumbent is the only possible source for a particular item (despite
what a procurement organization might believe). Given this, a
good first question to ask to get the topic moving is “where
do your three closest competitors buy their equivalent product
In most cases we find that there are alternatives when we scour
the market. But when we dig below the surface and present options,
we often find that there are a variety of reasons our client will
not want to change suppliers, despite the availability of like
or substitute products. To get past this point, it often helps
to pose an additional question: “if your competitor is able
to compete with you based on this supplier why would they not
be a viable alternative for you?”
Often switching direct materials suppliers is not a simple process,
even if alternatives do exist. A change to an alternative supplier
might involve design changes, re-engineering, capital expenditure
and/or the re-writing of proprietary systems and software. But
while these issues can add complexity into the equation, it is
critical to not lose sight of what a company is trying to achieve—the
creation of alternatives and options.
Options are wonderful things. The moment a client has options
they cease to be wholly reliant on the incumbent supplier. Once
a buying organization has real options, the incumbent must respond
to a competitive environment or risk losing the business.
What’s critical to remember is that the more an organization
invests in a detailed analysis of alternative sources of supply,
the more convincing it will be in showing the incumbent that they
are serious. One of our key observations is that threatening competition
is a waste of time. Action speaks far louder than rhetoric when
it comes to negotiation. For example, a company has far more leverage
with the incumbent supplier if they have an alternative supplier
running product trials in their plant than merely name dropping
a competitive supplier during a negotiating session.
In some cases, we find that the best force of action involves
competitive online negotiations (such as reverse auctions) when
there are enough qualified sources of supply. While the reverse
auction has both advocates and dissenters, it does have the power
to graphically illustrate to incumbent suppliers just how uncompetitive
their prices are compared to the market.
But buying organizations should never use reverse auctions lightly.
For instance, we have never run bidding events where the sole
purpose is to pressure incumbent suppliers to reduce their costs.
We believe that there is a strong ethical argument that to be
effective, reverse auctions need to be seen as fair by all the
participants, and that all participating suppliers need a fair
chance at winning the award decision.
The good news is that even if there are re-engineering costs
or other barriers to changing suppliers, it is still possible
to set up reverse auctions with handicaps for new entrants—based
on actual, quantifiable switching costs—that allow all parties
to compete on a fair and equal footing. And if after an event,
the alternatives are still significantly cheaper, then the price
discovery process actually aids the other major hurdle to changing
suppliers—resistance from within the current buying organization
to change. But that’s the subject of a future essay!
Stuart Burns is
Managing Director of Aptium
Global where he leads the firm’s practice in Europe