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 This Issue—Volume 1, 2006
In this seventh edition of Gunpowder, our blogger-in-residence Jason Busch, tackles a heady but scary topic—the impact that potential scenarios 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:

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:

  1. 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.)?
  2. 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?
  3. 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?
  4. 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?
  5. Along similar lines, for larger organizations, how integrated are our trading and procurement functions?
  6. 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?
  7. 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?
  8. 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?
  9. Are there any technology specific or related investments that we can make in the near-term to better manage supply risk?
  10. 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 smart idea.

In his spare time between running a boutique consultancy and advising Aptium Global, Jason writes the acclaimed Spend Management blog:

Our Take: Analyzing Aberdeen’s Take
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 room).

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 America.

The Incumbent Supplier Conundrum

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 alternatives.

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 from?”

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 and Asia.




This newsletter is published by Aptium Global Inc a direct material advisory firm based in Chicago, IL. With offices in the UK, China, India and a network of global associates, Aptium Global works with small and medium sized manufacturing companies to save money on direct material purchases. Smaller companies face the same cost pressures as the Fortune 500, yet often lack budgets for cost reduction services. Aptium Global works with organizations on a pay-as-you-save™ basis, minimizing impact on cash flow and maximizing impact on the bottom line. We aim to publish this newsletter on a monthly basis but reserve the right to miss a few deadlines here and there.

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