Articles-2

 

Many purchasing professionals simply attach a supplier’s quotation to the standard terms and conditions boilerplate and then move forward with that as the contract.  This is a huge disservice to your company, and is one of the reasons why buyers and internal customers are often so busy chasing after and dealing with supplier excursions, with no time to be proactive the way they would like.

Say for instance that there is a purchase of computer servers being made for an information technology data center of a company in the financial services business.  Since the data center houses absolutely critical customer information of the highest order, uptime of the data center is of the utmost importance.   Let us say that for this particular purchase, the warranty clause in the standard contract reads as follows:

XII.     Product Warranty

A)    The Supplier warrants that the Goods supplied under the Contract are new, unused, of the most recent or current models, and that they incorporate all recent improvements in design and materials unless provided otherwise in the Contract. The Supplier further warrants that all Goods supplied under this Contract shall have no defect, arising from design, materials, or workmanship (except when the design and/or material is required by the Buyer’s specifications) or from any act or omission of the Supplier, that may develop under normal use of the supplied Goods in the conditions prevailing in the country of final destination.

B)    15.2 This warranty shall remain valid for twelve (12) months after the Goods, or any portion thereof as the case may be, have been delivered to and accepted at the final destination indicated in the Contract.

C)    The Buyer shall promptly notify the Supplier in writing of any claims arising under this warranty.

The supplier agreed to all of this language in the standard contract, so you are covered, right?   Not at all, in fact.  In looking at the warranty clause above, if the internal customer’s top concerns with this purchase are that there must be 100% server uptime with a maximum one day replacement on defective items, then the standard warranty clause above will not meet these expectations.   In fact, the supplier can take 3 weeks to replace the defective server and still not be in breach of the contract.  Or they may want even more time to try and fix the defective server.   Further, if the server is replaced, it is not clear who will pay for shipping costs on both returning the defective server and receiving the new one. Finally, a one year warranty isn’t nearly enough for an expensive server purchase – a minimum of three years warranty should be provided for such a purchase.

Remember, the contract doesn’t “know” if you are buying computer servers or toilet paper. The contract clause in the example above would therefore need dramatic modifications before it could be suitable for the purchasing professional’s requirements.  If the purchasing professional were to simply affix the supplier’s quotation to this contract as is, the negotiations may go quickly, but the real problems will begin later, and by that stage, they are much more difficult and time consuming to address.   Meanwhile, there could be costly datacenter downtime, which could mean substantial customer loss, and therefore revenue loss.  This is every purchasing professional’s nightmare, and it is easily avoidable by simply customizing the contract to the specific purchase requirements.

I teach the details of customizing contracts in my Purchasing Contract Law seminars, such that purchasing professionals have the necessary knowledge and skill sets to customize contracts to set clear expectations with suppliers, and have measures in place to handle excursions without the need for the purchasing professional to go into time consuming fire-drill mode.  Doing this properly will save the purchasing professional time, and will dramatically reduce the overall total cost of the business model with corresponding suppliers.

NFL Negotiations Example – leverage in negotiations

I have always wanted to write about an incident that happened in October 2009 in the NFL, and I’m finally going to do that now.  This is not a sports post, this is a negotiations leverage post – read and enjoy.

Back in 2009, the San Francisco 49ers were shocked to have record setting wide receiver Michael Crabtree fall to them at the 10th spot in the draft.  They drafted him without hesitation, not even waiting until their time allocation to make a decision was over, meaning they weren’t even going to listen to trade offers from other teams.  They were getting Michael Crabtree, period.

The 49ers were not a good team at this time, and they desperately needed Crabtree’s services.  The problem was that Crabtree was upset that he fell to the 10 spot in the NFL draft, and he wanted the kind of money that he felt he should have gotten if he had been picked in the top 3 picks, like he felt he should have been.  His agent told him to hold out – to not sign the contract – and to not play in games.  They walked from the negotiation table and the two sides stopped talking for weeks.  Out of the hundreds of NFL draft picks, Crabtree was the only one holding out into the regular season like this, forfeiting game checks and playing time.  The gamble was that the 49ers would lose all their games, see how badly they needed Crabtree, and come back to him on their hands and knees, and agree to all his terms in negotiations.

Great strategy.  Except it didn’t work.  The 49ers were winning without Crabtree, and negotiation leverage was shifting to them.  Crabtree got nervous, very nervous, and he realized that he was the one who needed to come back to the negotiating table on his hands and knees.  How could he do it without losing face?  After all, it was his side that walked away from the table, and he just couldn’t deal with the humiliating idea of *him* coming back on his hands and knees.  He didn’t want to lose the leverage, and he didn’t want to lose face.  What could be done?  He needed negotiations to resume, now, but he couldn’t be the one who initiated them.

Enter MC Hammer.  Yes, MC Hammer.  Straight out of the 1980′s.  Shockingly, he was inserted in the negotiations by Crabtree, as a measure for Crabtree to save face, and to help as an unexpected middle-man to pull the two sides back together.  It was a surreal scene, but it was all Crabtree had left in his bag of tricks. The 49ers general manager and the 49ers owner met MC Hammer, Crabtree, and Crabtree’s agent at a hotel in the Bay Area for negotiations.   The 49ers owner, Jed York, was only there to show commitment to signing, but did not intend to be involved in negotiations.  Same with Crabtree.  Both he and York were going to let the contract guys hammer things out (no pun intended).  However, on his way out, Crabtree pulled MC hammer aside, cupped his hand over his mouth, and whispered a few words that nobody else could hear, quietly into MC Hammer’s ears.  These were negotiation directions for Hammer, and for Hammer only.  There was a problem however.  York heard it.  He somehow heard it.   What did Crabtree say?  Crabtree whispered to MC Hammer “make it happen.”   Three words.  “Make it happen.”  Just like that, all of Crabtree’s negotiating leverage was gone. All of it.  Crabtree had sealed his fate.

York left the hotel in a rush, and then immediately called the 49ers General Manager and chief negotiator from the parking lot and told them what he heard, and told him to play ruthless and relentless hardball on all the issues, because Crabtree instructed his team to strike a deal that day, and they would be forced to cave on all their negotiation points.  And that is exactly what happened.  The 49ers didn’t budge, and Crabtree’s agent and MC Hammer, under direction from their client, had to cave on all their objectives.  In the end, Crabtree got a deal that wasn’t as good as he would have gotten if he had never held out, he lost game checks, and he had to sign up for a 6 year contract instead of the standard 5 year contract – meaning he would land his anticipated big deal 2nd contract one year later than planned, which meant lost income in his 6th year.  He also had a “diva clause” inserted to make sure he played no such shenanigans in the future again.  That diva label still haunts him to this day.  All of this because of a failed negotiation strategy.

Negotiations are all about leverage and momentum.  Leverage shifts back and forth.  The goal is not to extort the other party, but sometimes big gambles can backfire, and you end up outfoxing yourself.  Crabtree tried to act like he was sending out an RFP to multiple suitors, but instead found out he was sole sourced with no options at all, and ultimately he paid the price for this negotiation mistake.  Purchasing professionals should learn from this example and always keep negotiating leverage on their side.

Should Cost Modeling – What Every Purchasing Professional Needs to Know

I have noticed over the years that there are two things that purchasing professionals are consistently apprehensive about.  The first is legal issues in negotiating the specific terms and conditions of the contract, and the other is cost modeling.  As a consequence, they look to the legal department to drive legal issues and the finance department to drive cost models, or worse yet, they try to minimize the role of those two in their overall role, in an effort to focus in other areas.  These are both mistakes.  Purchasing professionals need to make these things their friends and success enablers, not their enemy.

I’m going to focus on the cost modeling aspect today.  There are different types of cost models – must cost, total cost, and should cost.  Must cost is a budget driven model that covers the not to exceed cost parameters of a purchase, and breaks into the nuts and bolts of the cost components to ensure this budget is met.  Total cost looks at the end to end cost of ownership of a purchase, of which purchase price is only a component.  Should cost, the focus of this blog, is an analysis of what a supplier should be charging for something and comparing that to what they are charging, for the purpose of lowering the total cost of the purchase through such compelling analysis.

Should cost modeling is typically not quick and easy, and therefore should only be used when required, as opposed to being used whenever possible.  When apples to apples benchmarking of prices is available, this should always be the preferred method.  For instance, if there is a janitorial RFP that goes out, the responses by definition will be apples to apples, and can be benchmarked against one another.  There is no need to do a should cost analysis, unless there is the belief that all the suppliers came in high.  Custom purchases are the prime candidate for should cost models, because there is nothing to benchmark against, and there needs to be some basis upon which the purchasing professional comes back and uses to negotiate a total cost reduction.

The analysis does not need to be exhaustive.  In fact, the more exhaustive a should cost analysis is, the more likely it is to be wrong.  The reason is that every cost model contains three components:  facts, estimates, and assumptions.  These three have varying levels of certainty associated with them.  Making a cost model – any cost model – more exhaustive and comprehensive entails expanding the number of estimates and assumptions that are included. This will decrease the reliability of the output of the model.

Let us say that there is a software consultant that an internal customer wants to hire.  The customer insists that nobody else can do this work, therefore you are not really able to benchmark. The software consultant wants $400/hour – not an unlikely demand.  You have no choice but to do a should cost model.  If you ask the internal customer what they would pay this person if they were to hire them as an employee (never mind that this is not an option that either party desires), this is a base figure to work off of.  Let’s say this consultant would make $150K/year internally.  But there are still overhead and burden costs.  Let’s say those represent 40%, bringing the total to $210K.  There are still industry average profit margins in the consultant’s industry to add on. You must look up the NAICS code for technology consulting and add that on – let’s say that is 30%, bringing the total to $263K.  Now you are not paying them by the year, you are paying them by the hour.  The average employee works 2,000 hours a year.  That brings the hourly rate down to $131.50/hour.  Wait – why is the supplier charging $400/hour again?  This is the data you show the supplier, and while you likely won’t get the supplier down to this hourly rate, you do bring them down to earth with this analysis and force them to explain why they are charging three times what your cost model indicates they should.

I have public and private seminars that get deep into the nuts and bolts of doing this kind of analysis.  This serves as critical information that every purchasing professional should employ as pivotal aspects of their negotiation planning strategy.  Know it well.

ISM™ 5 Week Teleseminar Series: Taking Costs Out Of the Supply Chain

ISM™ 5 Week Teleseminar Series:  Taking Costs Out Of the Supply Chain 

To register, send an email to ISM Sacramento Director of Education Steven McCredie at smccredie@hotmail.com

Having a hard time meeting your cost savings goals?  How many times can you ask the same supplier for a lower price?

Stop Spinning Your Wheels!

 The Solution: Shift your model from asking the supplier to make less money so you can get more savings (which is what the supplier hears when you ask for a lower price) to a collaborative approach that removes costs from the supply chain, benefiting both parties and generating better results.

The Institute for Supply Management™ is offering a 5 week LIVE teleseminar series – one hour per week – every Tuesday at 10AM PST in the month of September and the first week of October. PC and phone access are needed for these teleseminars. Upon completion, you will get 5 hours continuing education credits.

Learning Schedule

September 4th – Price reductions vs supply chain cost reductions + examples

September 11th – Identifying target suppliers and key opportunities

September 18th – Making the internal pitch; getting management approval

September 25th – Getting suppliers on board and setting expectations

October 2nd – Driving implementation and expansion with target suppliers

To register, send an email to ISM Sacramento Director of Education Steven McCredie at smccredie@hotmail.com

 

The price for this series is $100 for all 5 teleseminars.  This is a special ISM rate (normally $349).  This session is open to all purchasing professionals, irrespective of geography – however, session size is limited.  There will be time at the end of every session for Q&A with the instructor. 

About Your Instructor:  Omid Ghamami is President & Chief Consultant at Purchasing Advantage.   Since 1995, he has taught thousands of hours of purchasing seminars all around the world.  Omid is also an Adjunct Professor of Purchasing at Folsom Lake College, and is the founder and developer of their program.  Omid has a rich history publishing ISM articles and teaching seminars at various ISM chapters.

What Win/Win Negotiations Really Mean

There are many purchasing terms that are used on a regular basis, but unfortunately some of them have gotten overused, misused, and misunderstood to the point that they are cliches instead of powerful expressions of intent.  Probably the best such example is the expression “Win/Win”.  Purchasing professionals should not use this term unless they intend to role model it  as well.  Suppliers will interpret your actions, not your words, and if your words do not translate into action, or if your actions are inconsistent with your words, then your words become meaningless – and having your words become meaningless in a business where the ability to influence is second to none is career suicide.

Similarly, while many purchasing professionals have unintentionally used the term win/win in a cliche fashion, there are still another set that use Win/Win to mean that there must be price concessions made to the supplier, so that both parties “win”.  This same strategy is then taken to every line item being negotiated, such that both parties move from their position.  This too is a fatal strategy, and in fact represents “Lose/Lose” negotiations, because neither party gets what they wanted!

Finally, many purchasing professionals come into negotiations assuming they know what it takes for the supplier to “win”.  Most commonly, the biggest supplier win-factor is assumed to be price related, which surprisingly is not always the case, and perhaps even not often the case.  It should never be assumed or presupposed that the supplier needs a higher price in order to “win”.

The only way to achieve win-win is through as strategic concession management methodology in which the supplier’s needs and wants are explored, understood, ranked, and then assigned a purchasing cost value.  Some areas will be high return for the supplier but low cost to the purchasing professional, and those are almost always non-price related.  The purchasing professional should develop a plan to utilize such concessions to achieve their objectives.  I go through this methodology in deep detail in my public and company private seminars, including templates and process steps.

The net result of this approach is that the purchasing professional can meet and exceed their total cost objectives while giving the supplier what they want out of the deal, and at the same time have them feeling very good about the outcome – with a renewed sense of commitment and loyalty to making the purchasing professional successful.  This is the true measure of a savvy negotiater, and is the only true definition of Win/Win.  Use these skills and go off and do something wonderful!

1 Comment

Why cost avoidance savings are the best savings of all

Part of the challenge of being a purchasing professional is trying to establish value for managment and internal customers.  Customers may frustrate purchasing by asking questions like “if you saved me that much money, then how come I don’t have that much extra in my budget?”  Educating customers on how purchasing tracks savings and getting them to see the value is key to getting them on board.  This won’t work unless real examples are used, outlining direct, indirect/soft, and avoidance savings.

Direct savings are the most well understood – they are the function of price reductions from what the supplier is asking, or the last price paid, whichever is less.  In other words, it is a measure of what difference the purchasing professional made in price paid for the product or service.  Indirect/soft savings are the quantified value of non-price related negotiated concessions. This deserves its own blog, and I will write about this soon, as this is the source of much confusion for buyers, internal customers, and even suppliers!  Cost avoidance savings are those savings which are the result of expenditures that the purchasing professional took measures to ensure never take place at all.   This include the function of performing validation of customer demand, which traditionally is a function performed by the customer’s manager and finance representative – but is also an area to which purchasing is entitled to – and should – pursue.  Remember, the real customer is not the person who is generating the demand, but rather the board of directors and the shareholders (in the case of public companies) – they would want you to reduce the total cost of the purchase by all avenues available to you, inclusive of validating demand.  Let us look at some examples:

* Convincing the customer that fewer units are needed to accomplish their objectives

* Influencing customer to get rid of some bells/whistles in the product that they are requesting

* Identifying existing available internal resources that the customer can use in place of buying new ones

* Determining that another purchase elsewhere can be avoided as a result of this one

* Working with the customer to modify a services SOW to include fewer cost drivers

All of the above actions will result in entire line items of cost to be avoided altogether – hence the term cost avoidance.  Here’s the clincher: cost avoidance savings are the BEST savings type of all, because they are 100% savings!  That is exactly how they should be marketed internally to customers and management alike, and that is why they are so valuable.  I run into purchasing departments all the time that have an internal management team that does not accept or recognize the tracking of cost avoidance savings, and I always have to convince them otherwise.  Cost avoidance savings are not a nebulous and intangible cost savings, they are the greatest savings of all – 100% savings delivered straight back to the bottom line.

1 Comment

Risk Assessment, Controls, Business Continuity, and Internal Audit – Get in the driver’s seat

Purchasing professionals shudder at the thought of internal audit coming around.  What will they find?  Is my paperwork in order?  Where did I put that contract?  What kind of questions will they ask me?  Will I look bad?  Will this affect my review?  What will my boss say?  How can I scramble and prepare for all of this?  “Preparing” for an internal audit is like trying to cram in one year’s worth of flossing before an annual dental checkup.  It’s a sign that something is wrong.

Luckily, there is a pretty easy way to make all of this less painful.  The first thing you have to know is that you are a lot smarter than internal audit regarding purchasing.  They know risk and controls pretty well (risk is the possibility of something happening, and controls are measures in place that mitigate risk), but they generally don’t know purchasing that well, because they have to audit many different groups and yours is just one of those.

Step 1 is to do a risk assessment. This involves gathering stakeholders from different aspects of the business – customer, purchasing, A/P, finance, etc and forming a small team, and assessing the risk of every aspect of your operations.  Sounds difficult?  It doesn’t have to be.  Just start with demand generation, and work your way through fulfillment of payment. Other areas can be assessed too, such as supplier and contract management.  Gather every single risk that can manifest itself from beginning to end of this process.  They are the same in every company; customer works with wrong supplier, customer gets kick backs, customer agrees to deal without purchasing, customer buys wrong product, customer buys too much product, purchasing is getting kickbacks, wrong kind of contract put in place, bad contract put in place, purchasing negotiates bad deal, purchasing is losing their contracts, supplier expenditures aren’t being tracked, supplier is being paid for items not received, etc.  Work your way through the end of the process and document all these risks and put them in a spreadsheet, line by line.  In the next column, put the probability of these risks manifesting themselves.  You can assign a figure of 0 to 1 (1 = 100% probability), or low/med/high.  In the next column, put the impact of the risk manifesting itself, using the same metrics.  The next column needs to show what types of controls are in place currently for each risk.   Controls can be automated, manual, preventative, and detective.  An example of a manual/preventative control is when you want to go through security at the airport.  A human has to manually screen you, and you are prevented from entering the terminal until having passed screening.  An example of an automated/detective control is a monthly auto-generated inventory report that shows how much shrinkage there was in the last month.  A computer did the analysis, but the shrinkage already happened – it is being detected, not prevented.  For wherever there are gaps in the risk assessment, there should be controls put in place and documented, and it should be noted what type of control is being put in place.

Now you need to look at the spreadsheet and look for gaps.  Where is there intervention needed?   There are multiple scenarios that merit intervention. The first is where there is insufficient control or the wrong type of control in place.  The other is where there is too much control in place – more than what is needed.   The wrong type of control could be one that is detective instead of  preventative or it is manual when it could be automated.  Too much control could be a case where too much energy is put into something that isn’t worth controlling, or something that is worth controlling but there are too many controls in place, both of which can result in departmental inefficiencies.

Both existing and new controls need to be documented as a result of this analysis.  Then, this document should be proactively reviewed with internal audit for inputs.  They will provide inputs and will indicate if they think the plan is good or not.  They will not approve it however, due to the arms length nature of their role.  If they think it is good, then you have captured their confidence.

The purchasing department then needs to embark on a periodic self-audit process (quarterly is good), whereby individuals audit themselves, and peer audits happen within the department.  This is a safe and non-threatening process that is meant to help each other out, not “catch” offenders. Internal audit should be made aware of this process.  Then if and when internal audit does come, a copy of the risk assessment document should be given to them, and they should be told to audit the department against those controls criteria – your own critiera.  They won’t agree to this in advance, again due to the arms-length nature of their job – but I have never seen them actually do otherwise, because as stated before, they may be experts in risk and controls, but they really don’t know what exactly to look for as they go from auditing one department to another.

The worst situation of all is when internal audit has findings that you know are not ideal for the business, but your department now needs to implement those by corporate mandate. That should never happen.  Use these process steps to get pre-aligned with internal audit and gain their confidence so that they come less frequently, and when they do, they audit to your terms and not theirs.

Leave a comment
Aug1

Managing Rogue Internal Customers

In going from company to company teaching purchasing seminars over nearly the last 20 years, the one theme that keeps recurring is frustration with rogue internal customers and with senior management that refuses to do anything about it.  I have yet to find a company with a documented AND enforced corporate policy of engaging purchasing early with consequences for violaters.  These policies, by and large, do not exist.  There is the constant dilemma of whether to use the carrot or the stick to get the customer properly aligned with desired purchasing processes of early engagement and managed supplier communications.  The answer is that both the carrot and the stick need to be used, but the primary method needs to be the carrot, and the method of last resort needs to be the stick.  I have not seen any other model work effectively in mid to large sized firms.  Let’s explore what this means.

Using the carrot involves intrinsic motivation, and using the stick involves extrinsic motivation.  Using the carrot means customers align with purchasing practices because they want to, and using the stick means they align with purchasing practices because they have to.  Which one do you think produces better results?  Intrinsic motivation models always produce the best results.

With rogue customer groups, the entire group should not be tackled at once, the biggest and most immediate purchasing opportunity should be.  The particular end user with that requirement should be met with, and rather than “telling” them the rules, the purchasing professional should ask for the opportunity to partner with them to help them meet their objectives.  Focusing on the customer’s objectives in discussions will help to build intrinsic motivation.  The customer’s objectives and concerns should be reviewed and documented.  The purchasing professional should build their negotiation plan around these objectives, adding in total cost objectives.  From there, a disproportionate amount of the purchasing professional’s time and energy should be put into making this deal overwhelmingly successful.  Every single customer objective should be met or exceeded, and there should be a clear capturing of cost savings (direct, soft/indirect, avoidance).  The customer should be excited after purchasing if everything was done right.  They will be intrinsically motivated to work with purchasing in the future, always engaging them early.

That’s not the end though – we just have one internal customer in that group aligned, but not the whole group yet.  A summary slide or two of the negotiation outcome needs to be documented in a crisp and succinct presentation and presented to that customer’s staff (the one that s/he sits in), in a very brief agenda item, just 15 minutes is enough.  A summary of the deal, and the results achieved (focus on what “we” achieved when presenting) will get the staff’s interest.  The specific internal customer will be a walking testimonial, and will not only mention during that staff meeting, but also in future staffs the difference that purchasing makes when engaged early.  A short and documented testimonial (2 – 3 sentences) should be obtained from that internal customer and added into the above presentation.  This 1 – 2 page presentation then becomes roadshow material that can be presented to other organizations internally.  As more customers are aligned with, and more big wins come along, these should be added to the deck.  What you eventually will have is a set of documented results to show management and internal customers, along with the creation of set of internal ambassadors that are helping to support purchasing’s objectives – not because they have to, but because they would be crazy not to.  This intrinsic motivation model is critical to purchasing success in the customer base.

The stick has to be in place as well, but this needs to be the exception and not the norm, and it needs to be something that is *not* part of the roadshow marketing package, because the goal is to motivate, not scare customers into working with purchasing. This needs to be a separate agreement with a senior manager in the customer department, after purchasing value has been established and purchasing is perceived as being a valuable business partner and enabler.  The best model that I have seen is something that is called “the walk of shame,” whereby the rogue internal customer who submits a PO without having involved purchasing has to go to a senior manager in *their* organization (not in the purchasing organization) and explain to them what happened and why it won’t happen again.  Once any internal customer goes through this process, the rate of repeat rogue behavior with that individual person is nearly zero.

One win at a time, focus on customer objectives, intrinsic motivation models, diligent tracking of results, and a method of last resort for enforcing consequences are the key to the success of this model.  If done right, customers will police themselves and will be dedicated business partners with purchasing, and purchasing will have more time to focus on more value added activities, without the need for tops down corporate policies in place to support their customer alignment objectives.

Reducing the Supply Base – Stop Spinning Your Wheels

As I do seminars and training courses for different companies, there are always a few predictable things that are taking up the time of purchasing professionals and preventing them from spending more of their energies on lowering total cost.  One of those things is efforts aimed at reducing the supply base.  From my experience, 90% of suppliers on average in most mid to large companies are only getting 1 PO a year.  I’ll say that again – 90% of suppliers are only getting 1 PO a year (!).  This is largely driven by internal customers adding suppliers, most of which provide redundant products or services that are already supplied by the existing supply base.  Because many of these transactions are for dollar amounts that fall below purchasing’s radar (which for some companies can even mean transactions that are as high as $75 – 100K), these suppliers get added without purchasing involvement or scrutiny.  Making matters worse is that internal management of most every company I’ve been to is unwilling to lay down the law and have any punitive measures for rogue customers.   Purchasing professionals then spend endless time trying to reduce the supply base, one by one, by researching the details of the purchases with the suppliers in question and then removing them from the corporate supplier database.  I’m here to tell you this is a waste of time!

What purchasing professionals should be doing is measuring what % of their spends go to what % of their supply base.  The goal for indirect purchasing should be that 90% of expenditures go to 5% of the supply base, and for direct materials that 90% of the spends are going to 90% of the suppliers.  The reason for this variance is that direct materials typically do not carry large vendor bases and generally have solid controls in place over what can go into the final product and from which suppliers, nor do they have as much of a problem with rogue customer purchasing behavior, whereas indirect materials has a major issue with this, given the vast array of items that fall into this category.

Management needs to be convinced that this is the only indicator that matters, not supply base size.  Of course, those suppliers that fall in the 5% and 90% respectively for indirect and direct materials need to be suppliers that are contracted with and have aggressive pricing models in place.  What this requires is that the supply base is tiered.  Tier 1 is those suppliers that are long term, mission critical, supplier reviews are done, report cards are in place, and there is no planned intention of switching suppliers over time.  Tier 2 is the segment of suppliers that are also very critical, with supplier report cards in place and possibly supplier business reviews taking place.  Long term relationships are in place, but there is still the risk of supplier switches, though this is the exception and not the norm.  Tier 3 is everyone else.  For indirect procurement, this is the vast majority of the supply base (90%+++).  For direct materials, this is 5 – 10% of the supply base.

Once this tiering is in place, then purchasing needs to spend all their time investing in tier 1 and 2 suppliers, making them more capable, more total cost competitive, more employee friendly, better quality, etc.  These suppliers should be marketed internally and a Darwinian business model created whereby internal customers have no motivation to pursue or create Tier 3 suppliers because they can get those same items “better, cheaper, faster” from their perspective by going with existing Tier 1 & 2 suppliers.

Follow my lead – invest in Tier 1 and 2 suppliers, market them as being the best, most capable, & lowest total cost options and convince management that the new indicator for supply base management is what % of total spends go to what % of total supply base.  Don’t spin your wheels chasing after Tier 3 suppliers – it is a high investment, low return activity.  Give internal customers a compelling reason to want to use your Tier 1 & 2 suppliers, and you will find yourself with a more capable and streamlined supply base, as well much extra time to focus on more value added initiatives.

Leave a comment

Calling the Supplier’s Bluff – Can they walk from the deal?

Walking away from a negotiation is an often misunderstood tactic. Far from being a spur-of-the-moment decision or a method of dealing with heated emotions, it can actually be a strategy. When used correctly, it can enhance results without negatively impacting business relations.

Quite simply, to walk from the negotiations means that one or both sides is given time to reconsider their positions, with possibly significant consequences in the event progress is not made. The intent to walk should always be handled professionally; both sides should state their concerns, how they would like to see the situation rectified, why these issues are important to them, the logic behind these requirements, and the actions to be taken in the event no resolution is reached.

Often times, a supplier threatens to walk away if certain conditions are not met. This leaves the supply management professional unclear if the supplier is indeed serious or is using a clever negotiation ploy. As such, important measures should be taken before every negotiation to best prepare the purchasing professional.

When engaging in a pre-negotiation meeting with a supplier, six questions can provide key pieces of information to determine their level of need for the business — and, therefore, their ability to walk. If necessary, a non-disclosure agreement may also be signed by both parties to ensure confidentiality.

Question 1:

What percentage of your business will be coming from our firm with this proposed contract value?

How to interpret the response:
The intent of this question is to determine how important the business is to the supplier from a revenue perspective. The interpretation of the answer is very industry-specific. For some firms, even single-digit percentages are significant. If the organization is a conglomerate, or if its division is a separate financial entity, the focus should shift to the percentage of divisional revenue which the contract in question would represent. Concerns of detrimental reliance might come about if the percentage is too high (greater than 35% is a good rule of thumb). In such cases, the legal department should be consulted before contracting with this supplier.

Question 2:

Relative to your other customers, what is our organization’s expenditure ranking with this proposed contract value?

How to interpret the response:
The key here is to determine how your organization ranks compared with the supplier’s other customers at this level of proposed business. The importance behind this question is that the purchasing professional might find that, despite being a very small percentage of the supplier’s business, they are one of their top customers. Again, this should be assessed at the divisional level if it is a separate financial entity. Ranking in the top 10 is considered positive, and a ranking in the top five generally indicates a business opportunity the supplier likely cannot afford to walk away from.

Question 3:

Are you currently operating at full capacity?

How to interpret the response:
Another way to ask this question is, if the supplier walks away, will it be easy to fill the demand elsewhere? If they are operating at less than full capacity, they stand to significantly benefit from your business. On the other hand, if they are operating at full capacity and have other customers vying for the business, they might be able to walk away without consequence.

Question 4:

Are you doing business in any capacity with other divisions of our organization?

How to interpret the response:
Due to enterprise purchasing system limitations in large organizations, a purchasing professional might be unable to confirm if the supplier in question is already doing business with other divisions, or the extent to which they are. If this is the case, it is acceptable to verify this with the supplier, positioning it as a validation of data gathered by the purchasing agent. If the supplier is not doing business with any other division in your firm, and stands to lose your organization as a customer entirely, this weakens their ability to walk from the deal.

Question 5:

If an agreement was reached, are there any target dates for placing the first order?

How to Interpret the Response:
This question affords the opportunity for the supplier to disclose whether or not they would like to book the revenue by a particular date. Their level of desire should be evident; the more emphatic the answer, the less likely a walk-away. (This is especially true if a supplier is operating at less than full capacity.)

Question 6:

Are there any industry segments or new markets for which you would like us to use this contract as a gateway?

How to Interpret the Response:
This question ascertains whether or not the supplier wants to do business with your organization not only for the inherent value it presents, but also as a means to break into a new industry segment — as a foot in the door, so to speak. If the supplier indicates this is indeed their intention, ask clarifying questions to gauge the magnitude. The greater the opportunity, the less likely it is that the supplier will walk away from the business.

When assessing the big picture painted by these questions, points can be assigned to each category as an indicator of supplier negotiating strength. The purchasing professional should then be able to look at this trend data and make an assessment of the supplier’s ability to walk away based on what is at stake. Once this pre-work is done, any potential walk-away situation that arises with that supplier can be handled with confidence and resolve.

1 Comment