Tracking Cost Savings, Capital Reduction, and Avoidance

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The words of British engineer Lord Kelvin ring as true today as they did over a century ago: “If you cannot measure it, you cannot improve it.”

Every field develops metrics in order to understand performance. Such metrics are core elements of Key Performance Indicators (or KPI), which has applications in Purchasing. There, the objective is to improve work processes, programs, methods, or employees, in order to produce results that are effective and efficient. And above all, one metric stands out in Purchasing: Savings.

With consistency, research from universities, consultants, and purchasing associations has shown cost reduction as one of a company’s top three goals for the year. Simply put, Purchasing is the one company function that provides, without fail, fast and large-scale cost reduction.

Large companies use complex tools and processes to track and measure cost reduction, while smaller companies may track cost reduction via a simple spreadsheet. Whatever your methods, I recommend using Sourcing Activity and Savings (SAS), shown below. This simple spreadsheet allows you to track Cost Savings, Capital Reductions, Avoidances, Total Procurement Benefits (TPB), and Addressable Spend with ease and transparency.

Economic Concepts

The critical starting point is to work with Finance to define the criteria of each measure. Below are five crucial concepts to understand in the process.

Addressable Spend = The amount of spend that generates reported benefits.

Cost Savings = Also known as EBITDA impact, this is the impact on the income statement relative to the previous period (i.e., previous year). This is the difference between the costs in the previous period and the costs after the sourcing activity.

Capital Reduction = This is the impact on the balance sheet, the difference between the levels that existed before and the levels after the sourcing activity. This can include capital assets, inventory, and payment terms.

Avoidance = This is the price increase avoided, based on forecasted existing price vs. new price paid. It is also called soft savings to reflect the anticipated negative impact on the future Income Statement or Balance Sheet.

Total Procurement Benefits (TPB) = This is the total value created by Purchasing, namely, the sum of cost savings, capital reduction, and avoidances. It is the difference between the outcomes if Purchasing had or had not done the sourcing activity.

Expected vs. Realized Savings

At the time we calculate the benefits from a sourcing activity, we need the best estimate of the quantity expected to be purchased during the first 12 months following full implementation. To calculate the total impact, we need to multiply the quantity times the unit benefit (savings or capital reduction or avoidance). Basically, these are the expected benefits for the 12 months following project implementation.

For example, if the sourcing project is completed in June, then the benefits will be realized between July of the current year through June of the following year. In other words, the tracking of expected benefits and realized savings happen in a different time frame. The expected benefits are shown in the total value in the current year, whereas the realized savings will be shown part in the current year and the rest in the following year.

To be clear, we need to understand that Realized savings will not be exactly equal Expected savings because the Expected savings uses the best estimate of the quantity to be purchased during the first 12 months, whereas Realized savings uses the actual quantity consumed in the period. In my experience, it is not worth the effort to compare estimated quantity vs. actual quantity consumed, as Finance and Business are looking only for an order of magnitude of the savings, so this number does not need to be precise.

The Sourcing Activity and Savings (SAS) tool will track the Expected benefits (the metric to drive behavior in purchasing to perform more sourcing activities) and Realized savings (the impact in the income statement for the current and following year), which Finance and Business want to see.

Sourcing Activity and Savings (SAS)

Inspired by an existing client need, we have developed an SAS Tool where all Purchasing employees can input their sourcing activities to capture expected benefits.

Please click here to download SAS Tool

(For security reasons, the macro was disable. If you want the file please send me an e-mail to paulomoretti@pm2consult.com)

In addition to capturing the Addressable Spend, this tool automatically calculates Cost Savings, Capital Reduction, Avoidances, and TPB. Importantly, it also registers the request for price (RFP) and competitive bids so that leadership can approve the results of each sourcing activity.

Conveniently, there is also a tab that summarizes the results by employee and by commodity, along with the realized savings for the current and following year.

Once the tool and process are implemented, the company is able to report out benefits at any time up to the end of the year. For the following year, leadership is then able to set goals by employee and by commodity in terms of Addressable Spend and Benefits.

Taking Purchasing to the next level!

Paulo Moretti



Paulo Moretti is Principal at PM2Consult.com, a boutique consulting company focused on excellence in the purchasing function and market analysis of Chemicals & Plastics. Current SME assignments include: Efficio Consulting, GEP Consulting, Tenzing Consulting, Preferred Sourcing Solutions, and PLG Consulting.

Engaging Purchasing Stakeholders: A Framework that Works

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The recent Deloitte Global CPO survey 2018 contained several surprising results. Foremost among them for me was the low level of purchasing engagement between businesses and functions, that is, the purchasing stakeholders.

Purchasing stakeholders, by my definition, are the people in businesses or functions who are affected – either positively or negatively – by purchasing actions and decisions. Therefore, if the stakeholders are affected, it is imperative that you, the purchasing professional should actively engage with them.

The CPO Survey revealed that only “22% of procurement leaders are excellent business partners contributing significant strategic value.”  It was also found that only one-third have “good transparency” at levels below the Tier 1 suppliers.

This same survey further revealed that 76% of procurement leaders use only one approach to understand stakeholder requirements: the procurement team members who are embedded in cross-functional teams. In my view, this reactive approach is harmful to the purchasing function. Instead, we need a more proactive framework to define stakeholder engagement.

In the discussion below, we will identify stakeholders, justify engagement, and provide notes on a framework, approach, and governance.

Who are the stakeholders?

First, we need to identify the primary stakeholder in each commodity.

Organization designs for purchasing may vary, but most of them are divided into Direct and Indirect spend. Raw Materials and Packaging (RM & Pack) are commonly seen as part of Direct spend; Indirect spend typically includes Maintenance, Repair, Operation (MRO), Capital Expenditure (CAPEX), and Corporate Services. Logistics is divided between Direct (with freight costs from Truck, Rail, or Marine in RM & Pack) and Indirect (when freight is related to the sell side).

For RM & Pack, the primary stakeholders are the Business Director or Marketing Director. These are the people accountable for the profitability of the business when RM & Pack are the main input affecting the profitability.

For MRO/CAPEX, the primary stakeholders are Maintenance Leaders, Engineering Leaders, and ultimately the Plant Director. For Corporate Services, the primary stakeholders are the Function Leaders where we have a significant spend in IT, HR, Legal, Marketing, EH&S, Travel, and others. Finally, for Logistics, the stakeholders are Supply Chain Leaders.

A more traditional way to find the stakeholders has been to wait for something to go wrong in purchasing and notice whom to point fingers at. This failed approach underscores the importance of proactivity in stakeholder engagement.

Why stakeholder engagement?

Since stakeholders are affected by your decisions and actions, it is essential to engage with them. As I see it, there are four primary objectives in stakeholder engagement related to the actions and decisions made by purchasing.

  • Assure strategic alignment between Purchasing and stakeholders
  • Engage stakeholders in sourcing and project management
  • Engage stakeholders in selection and supplier management
  • Engage stakeholders in target setting and performance management

Following are five common concerns related to engagement (or the lack thereof).

  • Is purchasing aware of strategic business moves that can affect the supply chain?
  • Is purchasing informed about demand growth so that needed materials can be acquired on time?
  • Are stakeholders informed about supply market insights and price movements?
  • Are stakeholders aware of supplier performance?
  • Are stakeholders informed when their main product is being sourced?

Framework

Our framework is a simple, structured mechanism that is not time consuming for stakeholders. The model below can be used with any commodity with two levels of engagement. The higher level is the Steering Team, composed of the VP of Purchasing, the Purchasing Director, and the Business Unit President (or Function Head). The lower level, the Sourcing Council, is where most of action will take place.

Approach

Purchasing leadership should identify potential Sourcing Councils according to three criteria: significant spend, observed misalignments, and strategic impact on the organization. For accountability purposes, purchasing leadership should name one person to each Sourcing Council who is most knowledgeable about that area’s main products or services.

The selected person will prepare a presentation that includes Objectives of Engagement, Engagement Model, scope with defined purposes, and potential Sourcing Council Dashboard to be used. That person will then set up one meeting with stakeholders to make the proposal to create the Sourcing Council.

If a stakeholder decides to not engage in this model, the purchasing professional will at least have done his/her part in proposing the engagement, with the knowledge that the Purchasing stakeholders have been properly advised. On the other hand, if the stakeholder decides to engage, then quarterly meetings can be defined and stakeholders can decide what belongs in the Dashboard (see example below).

Governance

In order to track the progress of the sourcing councils, the Steering Team should create a quarterly mechanism to capture major implementation milestones. These would include when the proposal was done, when the first meeting happened, and when the Dashboard became operational (as shown in the example below for one specific quarter).

By using this tracking system, the Steering Team will know how much spend is possible according to Sourcing Councils, and then by each quarter, the degree of completion for proposals, first meetings, and Dashboard operationality. Once the Sourcing Councils are operational, the Steering Team is only advised when a Sourcing Council has critical matters to report.

Take-away

It is clear from the CPO Survey 2018 that there is a lack of engagement between purchasing and stakeholders. In order to change this picture, we need to be proactive and create a structured mechanism that aligns with stakeholder strategies, provides market insights, and has stakeholders participating in the sourcing activities, so that both sides can enhance the value delivered to the organization.

Taking Purchasing to the next level,

Paulo Moretti

Artificial Intelligence in Procurement: How will it affect you?

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On a daily basis, we see artificial intelligence (AI) impacting our lives, and its advancement is not slowing. It’s already at work in iPhone’s SIRI and Amazon’s Alexa. It’s just around the corner in self-driving cars (an area where my engineer son works) and in motorcycles.

AI powers search algorithms for Google, Alibaba, SAP’s Leonardo, and IBM’s Watson platform, which act in Sales (contextual marketing), Plant Management (automated defect detection), Supply Chain Optimization, and R&D (predictive diagnostics), as well as autonomous weapons. In Finance, 70% of all financial transactions today are performed by algorithms, a kind of artificial intelligence.

Major players like KPMG, Accenture, SAP, and IBM are betting that large enterprises will pursue cognitive procurement as the logical next step in their overall digital transformation.

I am not an AI specialist, nor do I have an IT background, but I’ve been collecting elaborate information on potential uses of AI in the Procurement arena. I am confident these can happen as soon as we solve some outstanding issues in our field. What follows is a historical review of AI, an examination of issues in procurement, and finally, a look to the future.

Background and Applications of AI

In the 1940s, the American mathematician Norbert Wiener (1894–1964) invented cybernetics. According to Wiener, the behavior of systems could be controlled by means of suitable feedback, but the necessary technology was not available in his time. That, however, has changed, and the technology is definitely here.

Following are several ideas for using AI technology in a business context:

  • Pattern recognition: Understanding typical trends or behaviors for customer financial transactions and spotting anomalies in an account’s spending data to identify potentially fraudulent behavior.
  • Prediction: Capturing short- and long-term variability in data to improve forecasting of energy consumption or predicting future prices.
  • Classification: Examining animal track images and grouping them by species type to support wildlife conservation efforts.
  • Image recognition: Determining if nodes on a patient’s raw CT scan are malignant or benign, or face recognition in iPhone X.
  • Speech to text: Transcribing customer call center voice messages to text for detection of sentiment and further analysis.
  • Cognitive search: Offering personalized recommendations to online shoppers by matching their interests with other customers who purchased similar items.
  • Natural language interaction (NLI): Telling a software application to generate a report on sales revenue (or procurement spend) predictions without making humans run the reports.
  • Natural language generation (NLG): Getting summaries of everything that has been analyzed from a large document collection.

This fine article about use of AI in business recently appeared in the Harvard Business Review: Robo-Advisers Are Coming to Consulting and Corporate Strategy.

Procurement Concerns with AI

According to the 2017 Deloitte Global CPO Survey, Procurement leaders reported these significant concerns:

  • 49% – Quality of data
  • 42% – Lack of data integration
  • 29% – Skills/capabilities of analytics resources
  • 29% – Current technology
  • 26% – Limited understanding of data technology

So, massive hurdles due to legacy enterprise IT systems and data silos

The first two issues reported by Procurement leaders are the major hurdles to implementing AI in Procurement. I experienced precisely such challenges dealing with quality of data and data integration when I was responsible for implementing Spend Analytics at Dow Chemical Co. (now DowDupont). Based on this experience and exchanges with other large companies, I have learned that the bigger the company, the bigger the data issues Procurement officers will face.

Dow used to run SAP R2 with thousands of modifications, while simultaneously running SAP R3 from its Rohm & Hass acquisition, plus 12 legacy IT systems (mainly MRO). ERP systems (like SAP) force us to code any raw material (SKU) and packaging so the system can calculate the variable cost for income statements. Even with forced coding, we find the same raw material with different codes or different names, including trademarks, even when English was the only language used.

The nightmares begin when you go to MRO (maintenance, repair, and operation), Logistics (freight), and Services. This is where the system does not force a unique code, the language is not necessarily English, and systems are different. Another issue is the lack of discipline in supplier names and codes. There are dozens of different names for the same company, which could include different legal entities or even simple misspellings.

Dow solved the problem years later by replacing everything with a new SAP platform. The key to this change was the leadership from the VP of Purchasing (my boss) who had an IT background and understood the issues we were facing. She helped me define specific resources to create product codes, service codes, and supplier codes (parent-child relationships), so we could have the same, consistent data on a global basis.

Companies like DowDupont and others who have invested in quality data and data integration will be among those prepared for AI integration in Procurement.

Some Predictions

Deloitte’s CPO Survey offered a succinct summary of the high impact outlook of transformations in these segments. It observed, “Source to Contract is becoming predictive, Purchase to Pay is becoming automated, Supplier Management is becoming proactive, and these are all empowered by analytics and strong operational management.”

In an interesting article, Edmund Zagorin proposed the following ways that AI could rapidly transform enterprise Procurement organizations over the next five years:

  • Cognitive systems replacing supply chain assistants
  • Cognitive systems replacing purchase order systems
  • Cognitive systems replacing supplier on-boarding workflows
  • Cognitive systems forecasting prices, generating contract templates, and evaluating suppliers before a human does

I agree with the reasoning of these predictions but would add a cautionary note. The timing is ripe, but only for those companies that have solved issues of quality of data and data integration. A further caution is that these predictions are still at the operational level and are not yet strategic.

Next Digital Transformation

The biggest impact on Procurement remains yet to be elaborated. My vision of AI in this arena is related to strategic sourcing where AI will generate alerts, from thousands of sources, including our cleansed system, about what is happening in the market to help sourcing managers make decisions to benefit their specific business and the company as a whole.

For example, we know that Crude Oil, Coal, and Natural Gas costs affect prices of most of chemicals and plastics. We also know that Crude Oil affects freight costs, metals costs affect MRO, and labor costs affect services. We have seen that natural disasters, plant shutdowns, product recalls, and company bankruptcies have affected the supply chain. Finally, of course, the supply-demand balance affects what we all buy.

Once your company has done the necessary homework to internally fix the quality of data and data integration, AI will be able to map everything you buy, from any company and in any location, and then correlate them with cost drivers, supply chain network, supplier profiles, finance, and natural disaster news. That means AI can generate alerts (called Cognitive Insights)  that can impact supply, demand, and/or prices, allowing you to decide what action you might take to protect your company against supply disruptions or to create savings opportunities.

Companies like ICIS, IHS, and ChemicalInfo (in the chemical space) as well as Beroe Market Intelligence have the Procurement knowledge capital to work in this space. What they will need to do to continue their advancement, however, is to join with AI firms to develop the next digital transformation.

Take-away

Without a doubt, artificial intelligence is coming and is poised to impact the Procurement world. It will immediately impact jobs on the operational side and then begin to affect strategic sourcing by improving awareness about what will impact strategic decision-making. Once the companies can fix the quality of data and data integration within the company, they will be well positioned to make this world-changing leap.

Taking Purchasing to the next level,

Paulo Moretti

Getting the Purchasing Information You Need When You Need It

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Purchasing professionals have two core issues when looking to refine a supply strategy for their commodity: understanding the market and determining their best approach.

This article will advocate using micro-consulting, which can speed up this process immensely. However, before talking about this, let’s review a purchasing professional’s main needs.

Purchasing Needs

For any commodity, there are different suppliers, with different installed capacity and different services, some with a certain competitive advantage. Understanding the supply-demand balance for this commodity is key here because this balance will drive the price. If supply is high, price goes down; if demand is high, price goes high.

To find suppliers, there are general tools available like Engineering 360 or Kompass (for MRO). In my area of expertise, Chemicals & Plastics, purchasing professionals use ChemicalInfo, ICIS, or IHS Markit (all of which require a subscription).

For determining market price in Chemicals & Plastics, I have used ICIS, IHS Markit, or PolymerUpdate.

For analyzing supply-demand, there are not good tools available for MRO or other commodities. However, for the Chemicals & Plastics industry, I have found ICIS and IHS Markit very useful. If you are looking for a database for MRO or other commodities, there are many research companies specializing in these areas that could generate and sell you a report.

Naturally, there is a cost to accessing such sources, and for some companies it makes sense to purchase a subscription. An effective alternative is to engage experts to get similar information in a process called micro-consulting.

Consultant Networks

One well-known solution is to hire a consultant company specializing in Purchasing like Efficio Consulting or Tenzing Consulting.  Both are viable options, where I also provide my services for the Chemicals & Plastics industry. Such agencies can provide full services to purchasing professionals, including organizational design, skill assessment of personnel, supply strategy development, and even full sourcing for your entire spend.

Other consultant companies function as a network of experts, where the consultants are not direct employees, but are affiliated or part of an expert database.

Companies of all sizes, even the Big 5 consultants, private equity firms, and fund management organizations, use these networks to find specific experts for micro-consulting. These clients (like you) call the network and explain their needs: what kind of expert they are looking for, which expertise is needed, which commodity is sought, which region is targeted, and perhaps even expertise on a specific company.

The networks scan their database of existing profiles to match the needs with the expertise available. Then the client submits 3-5 questions for the candidate experts to answer and demonstrate their knowledge. Once the client is satisfied, the network sets up a conference call between the parties. The call may be single-blinded, where the expert does not know the client’s identity, or there may be no restrictions placed.

The cost to the client (like you) is charged by the hour, where only the minutes consumed on the call will be charged. Hourly rates run from US$300 to $3000, depending on the expert.

The advantage of this approach is its cost-effectiveness because the client gets the exact information he or she is looking for. In the case of Purchasing, the client will understand:

  • The main suppliers in the market with their installed capacity
  • Which supplier(s) will have some competitive advantages
  • The current price in the market and the main cost driver
  • The demand in a specific region, growth drivers, and growth rates by end-use application
  • Future perspectives on supply, demand, and price
  • Types of contracts, including which possible clauses are common in the market
  • Alternative approaches for negotiation (a very important consideration)

Over my career, I have used these networks for my clients to obtain specific kinds of information, and it proved an excellent method to the get the data needed to define a supply strategy when time was constrained.

I have also been part of these networks, providing critical information related to Chemicals & Plastics to clients across all continents, made extremely efficient by use of telephone.

My personal networks number more than a dozen, including GLG, Coleman, GuidePoint, Third Bridge, AlphaSights, and Catalant. A complete listing of networks can be found at The Expert Networks.

Take-away

Whether you are brand-new or an experienced purchasing professional, you can always learn more to refine your supply strategy. More information equals better decision-making, which equals better supply strategy. In the final analysis, you can use the tools mentioned above or buy a subscription in your purchasing area. Alternatively, you may try a micro-consulting arrangement from a trusted consultant network. In this case, their experts may provide you critical data that is not published anyplace else. It is worth considering.

Taking Purchasing to the next level,

Paulo Moretti

MEASURING PURCHASING MATURITY

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The life of a purchasing executive is filled with doubt. I know because over the years, corporate purchasing managers have bombarded me with questions.

  • Do I have the right tools for purchasing?
  • Do I have all work processes in place for purchasing?
  • Is my staff adequately equipped to perform strategic sourcing?
  • Is my purchasing organization designed to meet the company’s needs?
  • Which metrics should I have in purchasing?
  • Where can I best improve the purchasing function?

From my experience, these questions all have one thing in common: Purchasing Maturity Level. The idea comes from research funded by the U.S. Dept. of Defense to develop the Capability Maturity Model (CMM), where the term “maturity” relates to the degree of formality and optimization of processes: from ad hoc practices to formally defined steps to managed result metrics to active optimization of the processes.

Background

From consultants across the industry, including my friends at AT Kearney, Efficio Consulting, Vantage Partners, and Tensing Consulting, a methodology has developed over the years to diagnose areas of opportunity to improve efficiency and effectiveness in purchasing function.

Each of these groups has developed questionnaires in their areas of expertise to map the strengths and weaknesses of purchasing dimensions like Tools, Internal Clients, Suppliers, Organization, Staff, Policy, Process, and Metrics.

These questionnaires, or tools, help the consultant detect which dimensions might be improved. Based on this diagnosis, the consultant might propose change management, a new process, new tools, or staff training, so that the company can understand where it is now, where it will be, and how it can get there.

My objective with this article is to demonstrate a tool for high-level purchasing executives to create an organizational self-assessment, so they can more fully understand areas for improvement, whether they are able to change by themselves, or whether they need to work with consultants on the areas for improvement. Each consultant will perform their own analysis with more sophisticated methodologies; however, this basic tool here can help executives begin thinking about potential changes for improvement in advance.

Purchasing Maturity Model

The model consists of a spreadsheet with eight dimensions to consider for purchasing maturity: Tools, Clients, Suppliers, Organization, Staff, Policy, Process, and Metrics. Each Dimension has several elements to be scored. For each element, users can select via the drop-down button the score that most closely reflects the purchasing function: 0, 1, 2, or 3 (with 3 rated as Very Mature). The score for each element has a description to guide user assessment. After scoring all 55 elements, the Result tab will show the maturity level in each dimension and the overall result for the Purchasing function.

This model divides the purchasing function into three levels with these descriptions:

  1. Starting / Performing: Purchasing is not a core competency. It is buried deep in the organizational hierarchy. Clients and Suppliers avoid interaction. Staff actively disengaged.
  2. Enabling / Optimizing: Purchasing is seen as a “value-added” function. There is some executive support and investment. Clients and Suppliers are satisfied for the most part. Employees are engaged but view this as a “job.” There are some spot best practices.
  3. Best in Class / World Class: Purchasing is strategic core competency. The organization is proficient at expected business practices. There is a high degree of Client and Supplier satisfaction. The organization is staffed with highly qualified professionals. There is a high degree of automation. It is metrics driven. It is an efficient and effective organization.

Results

The results of each analysis are presented in graph form for the eight dimensions, as well as the maturity level for each dimension, in a “maturity meter” with the overall classification, as shown below.

matuirity

From the above example, the purchasing executive would have a clear view that the first priorities for improvement are Tools and Internal Clients, and then the second priority is for Suppliers, Organization, and Staff. Of course, some changes in assessment may affect different dimensions, but consultants would know the best approach to most effectively implement changes.

After applying the tool, let me know if you have any questions.

Taking Purchasing to the next level,

Paulo Moretti

Embracing Supplier Diversity: Objectives, Resources, and Framework

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Diversity within an organization is seen as positive through many lenses: Diversity of ideas, of culture, of ethnicity, so why not also supplier diversity?

Corporations have already embraced diversity within the workforce and noticed benefits from it. Many of these benefits are outlined in the excellent book, Culture’s Consequences: Comparing Values, Behaviors, Institutions, and Organizations across Nations.

Supplier diversity is well developed in the U.S. but much less so in Europe. The process starts with corporate objectives, assesses the country resources, and finally, implements a well-planned framework.

Corporate Objectives

Critically, supplier diversity does not work if a corporation does not define it as a key objective for the business. Companies are often driven to start supplier diversity because of customer or government requirements. U.S. suppliers of Auto OEMs, for example, have been requested to provide information about their spend in terms of minority- or women-owned businesses. The same is true with local, state or federal governments, where suppliers must have some level of spend from minority-owned businesses.

Corporations that have defined supplier diversity as a key priority have reported benefits in four areas:

Corporate social responsibility (image)
Access to emerging markets and technologies (start-ups)
Community economic development near to their operations
New revenue driven by minorities (consumer level)

The first benefit can be seen at DiversityInc.com where they publish their annual Top 10 companies for Supplier Diversity and single out AT&T, Wyndham Worldwide, WellPoint, Ernst & Young, Hilton, KPMG, Marriott, KeyCorp, Accenture, and Abbott. There is also the Top 50 Companies for Diversity (featuring Novartis, Ernst & Young, PricewaterhouseCoopers, Proctor & Gamble, and others) that includes workforce and corporate culture.

Resources

It must be recognized that minority- and women-owned businesses have grown substantially in the U.S. In 2002 and 2007, the U.S. Dept. of Commerce (through the Minority Business Development Agency) published data based on the U.S. Census; showing minority-owned businesses (5,800,000 enterprises represented only 29% of companies) grew 47%, reaching US$1 trillion and 46 million jobs. Also in 2007, women-owned businesses reached US$1.2 trillion. As a comparison, the entire U.S. economy grew only 11% in the same period.

In the U.S., government guidelines classify minorities as follows: African American, Asian Indian, Asian Pacific, Hispanic, Native American, lesbian, gay, bisexual, and transgender, service disabled veterans, veterans, and women. These classifications are certified by the National Minority Supplier Development Council.

In Europe, the legislative and cultural acceptability for requesting and capturing data, particularly around ethnicity, is quite different. Europe identifies two preconditions for supplier diversity: “An understanding of diversity and the benefits it brings, amongst large corporations” and “a critical mass of under-represented businesses.” Only the U.K., France, Germany, and Sweden meet these preconditions. The data published by Supplier Diversity Europe in their Handbook on Supplier Diversity for 2008 listed 5,580,000 Micro, Small, and Medium enterprises, accounting for 90% of their companies. (No revenue data was available).

Framework

First and most important is to have supplier diversity as one of key objectives for the corporation.

The basic framework has three requirements: Standardize data, analyze spend, and establish metrics.

Standardize data. This is important because you need to understand your current spend in terms of vendors and commodities. Commodities like raw materials, packaging, logistics, MRO, capital, and corporate services must be classified (under UNSPSC codes or your own taxonomy) accordingly, so you will be able to define your targets.

From the Vendor point of view, your database will need to be standardized so you can consolidate spend for the same vendor with different names and also classify them in terms of minority status. Software vendors like D&B, Ariba, and Coupa provide software with minority classifications, so you are able to report how much spend has been from minorities.

Analyze spend. Some companies simply look at their total spend and then establish their goals and objectives from there. This approach can be used knowing that minority- and women-owned businesses account for 22% of the U.S. economy. Other companies prefer to cleanse the data in terms of availability, or which potential spend can be from minority suppliers. For example, you will not find minority-owned businesses supplying natural gas or crude oil (raw materials), turbines (MRO/capital), or marine freight (logistics). Some companies also include Tier 1 or 2 spend from minority suppliers; for example, auto OEMs ask their suppliers to report their spend with minority suppliers, so auto OEMs are able to report their own spend plus their suppliers, yielding a much larger figure.

Establish metrics: Optimally, you should look to define metrics at different levels like minority type (ethnicity, gender, etc.), comparisons to total company spend or cleansed spend, and company minority spend. Note that some companies also need to report minority spend at local or state levels in the USA or at national levels in Europe.

Spend can either be reported as total value (US$) or percentage of spend. Either reporting should have notes explaining if the value includes tier 1 and 2 suppliers, or in percentage, if it is based on total spend or cleansed spend.

Take-Away

Supplier Diversity is optional for any company. However, those companies that embraced diversity both as a corporate objective and a purchasing initiative have benefited from it.

Taking Purchasing to the next level,

Paulo Moretti

Client Satisfaction in Purchasing: A Must or Just “Nice to Have”?

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In Sales and Marketing, companies use Customer Satisfaction Surveys to provide indicators of consumer purchase intentions and loyalty. According to Wikipedia, “Customer satisfaction data are among the most frequently collected indicators of market perceptions.” It emphasizes that “[a]lthough sales or market share can indicate how well a firm is performing currently, satisfaction is perhaps the best indicator of how likely it is that the firm’s customers will make further purchases in the future“

In most instances, Purchasing provides services to internal clients, that is, businesses and functions within a company.  In other words, unless Purchasing is outsourced, there are no alternative sources for these services. In that case, why we should perform satisfaction surveys?

Client Engagement

In a 2013 article, Are You Engaging All Your Clients?, I gave my view of guiding principles to engaging Clients.

In summary, Client Engagement has four objectives:

  • Assuring Strategy Alignment between Purchasing and Client
  • Engaging Clients in Sourcing & Project Management
  • Engaging Clients in Supplier Management
  • Engaging Clients in Target Setting & Performance Management

Much has been written about elevating Purchasing’s stature to gain a “seat at the table” for strategic planning and decision making.  I believe that to be considered a Strategic Partner, Purchasing must begin with engaging the Client. Once you engage the Client, you set expectations in their mind and, from there, it makes sense to measure their satisfaction. The comparison of expectation and satisfaction is part of “The Disconfirmation Model” developed by Churchill and Suprenant in 1982 which is based on the comparison of Clients’ expectations and their perceived performance ratings.

Baseline

My view is that you should only start doing Satisfaction Surveys once you have established a Baseline to compare it. The engagement begins by interviewing the main Clients regarding four dimensions: Strategy Alignment, Sourcing Management, Supplier Management, and Metrics.

These questions obtain the Clients’ initial thoughts and scores from 1-6, with the following values: 1 (Extremely Dissatisfied), 2 (Dissatisfied), 3 (Somewhat Dissatisfied), 4 (Somewhat Satisfied), 5 (Satisfied) or 6 (Extremely Satisfied). Note that the scale forces the Client to choose between dissatisfaction and satisfaction alternatives, with no neutral zone.

For each dimension, we have a set of yes-no questions like:

Strategy Alignment Is Purchasing part of strategy development and the budget-setting process?
Is Purchasing involved in launching new products?
Sourcing Management Is the Client involved in sourcing strategy development?
Has Purchasing informed market trends, benchmarks, and forecasts?
Supplier Management Is the Client involved in supplier selection?
Has Purchasing shared supplier scorecards?
Metrics Has Purchasing shared savings / avoidances with the Client?
Has the Client defined specific metrics for Purchasing?

The baseline should be performed within each commodity (Raw Materials, Packaging, MRO, Capital, Logistics, etc.), so in the end you will have a baseline score for each commodity and also for all of Purchasing. At this point, you are able to do a gap assessment to understand the expectation from the Clients in each dimension as well as define actions to address the identified gaps.

Satisfaction Survey

Once you have a baseline to start with, you can perform Satisfaction Surveys. I suggest doing the survey just once a year through year-end interviews.

In order to obtain unbiased responses, I suggest selecting purchasing personnel from different commodities, e.g., Raw Materials purchasing personnel will interview Clients from MRO, and so on.

My preferred method of survey is to use a set of statements where the Client can give the Importance to them using Six Sigma ratings: 9 (very important), 3 (important) or 1 (less important). This is coupled with the 1-6 satisfaction scale from above. (See example below.) For statements with scores 3 or below, I recommend asking the Client’s reasoning, so you can identify other gaps to be addressed. At the end of the statements, the final question is the score for the overall satisfaction using the same scale.

 Survey

Take-Away

Satisfaction Surveys are a must-have tool. Any Purchasing function wishing to be considered a Strategic Partner within the company should be concerned about how its internal Clients are satisfied with the services provided. High-level satisfaction from your Clients is a moving target, and surveys are a way to find your path.

Taking Purchasing to the next level,

Paulo Moretti

Procurement Evolution: Purchasing, Strategic Sourcing and SRM

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Over time, most companies have made changes in the procurement function. Each starts with just Purchasing, evolves to Strategic Sourcing, and eventually adds Supplier Relationship Management (SRM). Because professionals in the field may have slightly different understandings of these terms, let me clarify what is meant by each.

Purchasing

Still today we can find companies where procurement activities are simply known as Purchasing. In those companies, procurement is just another function to buy “stuff” needed for company operations. Normally, they know one, two, or three suppliers for each product or service, and if they experience a price increase, they change to the supplier with the lower price. Little is required to perform the activities: Few processes or metrics, lower spend under management by procurement, and few skills—other than being a good negotiator.

Strategic Sourcing

Slowly, the Purchasing function evolves to Strategic Sourcing. This is mainly driven by manufacturing companies where the cost of their inputs ranges from 40% to 60% of their revenue. They start using Strategic Sourcing when they discover a huge opportunity—or need—for higher savings. Strategic Sourcing is the process that continuously improves and re-evaluates a company’s purchasing activities through the discipline of using five-, seven-, or nine-step sourcing projects. Besides a documented work process, metrics are created to drive behavior, with electronic tools (such as RFx, Auctions, Spend Analytics, and Contract Management) being offered in the market to automate the processes.

Most companies today have reached this level with varying degrees of sophistication, but no doubt a big portion of them wants to continue along this path because of the savings it brings to the company. The key question is how long this approach continues to bring savings year after year.

SRM

Most consultants today have embraced the concept of Supplier Relationship Management as the next evolution in Purchasing. The principle is very simple: Both Supplier and Customer are represented by people, people have interpersonal relationships, and relationships are dynamic systems that change continuously over their existence. If those relationships are not managed properly, they can deteriorate or terminate altogether. However, if key supplier relationships are managed, companies will maximize the value realized through those interactions.

Please note at the beginning of this text, I wrote that companies “add SRM” to their Purchasing strategy. This means that they continue to perform Strategic Sourcing to bring quick savings but can “add” SRM in order to elevate the value not obtained by sourcing projects.

The attached white paper describes the SRM approach developed by Vantage Partners. It includes SRM Program Objectives, Supplier Segmentation, Supplier Engagement, Supplier Governance, Joint Business Planning, Two-Way Performance Management, and an Illustrative Engagement Frequency. Click here for the White Paper.

For those companies that believe they are doing SRM, I strongly recommend participating in the SRM Benchmark to be able to compare themselves with other companies. This powerful benchmark has been in practice for almost a decade. It is used globally, covers all industry sectors, has already 670+ respondents, and will be open to new participants by November.

To begin the survey, please click here.

In December we will publish the results of this benchmark.  I hope you will join us.

Taking Purchasing to the next level,

Paulo Moretti

To download a PDF of this blog, Procurement Evolution, click here.

Taking Purchasing to the next level,

Paulo Moretti

Price Forecasting: Who Needs That?

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Common wisdom says that any price forecast is already wrong the moment it is published. I can only smile and agree with this. If people were able to predict the price of anything, they would be billionaires and very well known by now.

I’d like to hold this thought about price forecasts for a moment and talk about something we all know about: Weather forecasts.

Weather Forecasting

Historians tell us that Babylonians in 650 BC predicted the weather from cloud patterns. Around 300 BC, Indian astronomers developed weather-prediction methods. It was only in 904 AD that Wahshiyya, an Iraqi alchemist, began forecasting weather based on observed patterns of events called pattern recognition. The publication of written weather forecasts did not begin until August 1st, 1861 by Admiral Robert Fitzroy (in The Times of London). That means official weather forecasting turns 152 years old today.

Fitzroy started studying weather forecasting for a good reason. In 1859, a steam clipper named the Royal Charter was lost in a terrible storm with at least 450 killed. For years he published the forecasts despite strong criticism that they could not possibly be accurate. After much debate, his public forecasts ended in 1866.

From the BBC, “You have to admire Fitzroy for trying. He saw the big picture and walked the first few steps along a very hard path. Even now, when we have a sky full of satellites and enormous computational weather models, we don’t always get it right.”

Today, we all use weather forecasts to prepare for future events. From air and marine traffic, to crop reports and outdoor weddings, we all rely on accurate data to guide decisions on our safety, business, and social lives.  And despite our best technology, we still sometimes get it wrong.

Those criticisms of inaccuracy with weather forecasting most certainly apply to our earlier topic of price forecasting. However, for the savvy user, price forecasting can be an invaluable weapon in the Purchasing arsenal.  Let’s see how.

Futures Markets

Many companies already use futures markets in currencies, grains, metals, and energy, trading over US$1.5 trillion a year. Commodity prices are volatile according to the balance of supply and demand. To mitigate this volatility, a futures contract is an agreement to buy and sell an asset at a certain date at a certain price. That is, Investor A may make a contract with Farmer B in which A agrees to buy so many bushels of B’s corn at $15 per bushel. This contract must be honored whether the price of corn goes to $1 or $100 per bushel.

Futures contracts can add stability to certain markets, but they contain the risks inherent to all speculative investing. Here, then, is a prime use of price forecasting.

Price Forecasting

Purchasing deals with prices every day for diverse categories like Raw Materials, Logistics, MRO, Capital, Packaging, Labor, and other products and services. Some categories already have price forecasts done by well-respected companies like ICIS (forpetrochemicals, energy, and fertilizer), IHS Global Insight  (forcountry and industry forecasts), and many others in specific fields.

Many collect opinions from hundreds of experts to understand the trends and cost drivers to publish their forecasted prices. Others have developed mathematical models to predict future prices. To be sure, both methods incur inaccurate predictions. However if trends are identified, Purchasing can take a reasoned position about buying more or less, according to their perceived needs.

Models

Experts in price forecasting identify two kinds of models: Univariate and Multivariate.

  • Univariate modeling is based solely on the history of the variable being forecast itself, using trends, seasonality, and cycles. It is used for short-term forecasts.
  • Multivariate modeling is based on the history of variables and drivers like GDP, PPI, inflation, raw materials, etc. It is used for longer time horizons. Best practices say that each year of forecast requires four years of historical data.

Development Process

The eight steps below are based on my own experience at Fortune 500 companies where we developed models for Raw Materials, Logistics, and MRO, totaling US$12 billion of spend.

Define with category leader the product families to be forecasted based on their priorities and business needs. The definition must include the region and the lowest level of granularity as possible.

Using Mind Map, interview the purchasing expert to capture and visually outline the information about cost drivers. You must understand what affects the price of your product or service in each region.

Collect the external historic macro-economic data of all the cost drivers you are able to find. To maximize certainty, collect four years of data.

Collect the historic internal data of the product or service you want to forecast. Again, it is best to collect four years of data.

Using specific software from SAS (Statistical Analysis System), compare both internal and external historic data. The software is able to show which 3-5 external variables are most correlated with internal data by calculating the R-square for each variable (where higher is better).

Develop the forecast models where each variable participates in such proportion and time lag effect. For example, if the model is driven by GDP, PPI, and Raw Material X, the model may have a proportion of 3X, 2 PPI, and 1 GDP effect; it also includes the time lag like GDP 3 months in the future, with one month ahead for PPI and Raw Material X.

For each model, the software calculates the Mean Absolute Percent Error (MAPE), where below five is considered excellent.

Once all models are developed, one person from the category is able to update the recent historical data monthly or quarterly, run the model with the help of an Excel add-in, and publish the graph forecast to users and business clients. Each update adds one time horizon, keeping a 12- or 18-month horizon.

Price_Forecast.JPG

The above graph shows the historic internal data (dots) very close to the model (line), which reconstructed the past using past driver data. This means that the price forecast has 95% confidence.

Takeaways 

As with weather forecasting, people in Purchasing use price forecasting to prepare themselves for future events. Although never 100% accurate, they show us trends and patterns that can be used to avoid big losses.

Purchasing people have used price forecasting in order to:

  • Inform business clients about trends so they can take proactive price actions to prevent margin erosion.
  • Inform other internal clients for budgeting capital expenditures and freight costs.
  • Adjust product and service sourcing plans for buying more or less according to the needs and price trends.
  • Use repeatable data-driven methodology to understand price trends.

Although there is still criticism of price forecasting, just as with weather forecasting, it is only a matter of time before we adapt to it and learn how to use it well. With experience, I trust this process will not take us another 152 years to achieve.

Taking Purchasing to the next level,

Paulo Moretti

Are You Engaging All Your Clients?

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The market typically uses “client” or “customer” to designate recipients of goods or services in return for compensation. Today I’d like you to start to see your invisible clients, those recipients of Purchasing services inside your company.

The Purchasing function provides services to internal businesses and functions as well as to other companies. Based on a recent benchmark survey, commonly provided services include:

  • Strategic: Sourcing goods and services, supplier management, risk management, value analysis, supply strategy, and spend analytics
  • Operational: Account Payables, Contract Management, PO Processing, Supplier Scheduling, and Supplier Tracking

What is interesting is that Purchasing is similar to Sales in at least two functions: Providing services and attending to clients.

Sales and Customers

In representing a company, a salesperson provides goods or services to the customer/client, employing a work process to better assist the clients. Step #1 is to perform client segmentation to identify the strategic, preferred, and tactical clients. Each business within the company gets to define its own strategic clients.

Strategic clients are those you must give more attention, provide more services, and engage the leadership more frequently. It is well known that strategic customers will receive periodic visits from Directors, VPs, or even the CEO.

For strategic customers, salespeople provide market information, bring new products, discuss price trends, collect strategic insights for future development, and propose dashboards to follow up the projects and metrics agreed to by the customer.

Given all this attention to strategic customers, why don’t Purchasing organizations follow a similar framework with their internal clients?

Client Engagement

To create effective client engagement, companies must have three guiding principles: Accountability, clear interface, and governance.

  • Accountability: Clear roles, responsibilities, accountabilities, and metrics for both Purchasing and clients
  • Clear Interface: Client meetings that are well defined and clearly managed
  • Governance: Established mechanisms that ensure alignment at all levels across the organization

Following these guiding principles will improve your relationship and credibility with businesses and functional clients. More important, it will elevate Purchasing’s stature and obtain a seat at the table for strategic planning and decision making.

Approach 

Just as Sales has different businesses, Purchasing has different commodities, such as Raw Materials, Packaging, Logistics, MRO, Capital, and others. For each one, we can define the strategic clients.

For each commodity, I recommend developing a current statebaseline, performing a gap assessment, and then defining a prototype for further rollout implementation.

The baseline is developed through a series of 30 client questions. For example: What is Procurement’s role in this process today? What metrics are being used to measure procurement performance? What interfaces with the partner are used as part of this process? Is Purchasing part of strategy development and the budget setting process?

Each answer will have a score and the overall score gives the current state baseline. Comparing the current state with the ideal engagement model, you can assess the existing gaps.

Engagement Model

The ideal engagement model is to have Sourcing Teams reporting to Sourcing Councils, which in turn report to an Executive Council. Each level of Purchasing is engaged with a corresponding level from the business or functional clients.

Each Council has a clear definition of participants, roles and responsibilities, and frequency of engagement. Each Council then defines its respective dashboards with a spend profile, commodity dashboard, strategic alignment, spend to be sourced and benefits (savings/avoidances), and specific client metrics.

A yearly satisfaction survey will check how well the engagement is working and be compared to the baseline established at the beginning of this journey.

Engagement Objectives

For strategic clients, the objectives of client engagement should be to:

  • Assure strategic alignment between Purchasing and clients
  • Engage clients in sourcing and project management
  • Engage clients in supplier management
  • Engage clients in target setting and performance management

Our recent benchmark survey detected that 82% of companies have some kind of client management activity in place. However, only 33% perform a satisfaction survey.

With this in mind, there are several questions you need to consider: Do you have strategic clients? Do you have a formal engagement with these clients? Do you measure client satisfaction?

If you can answer yes to these questions, you have an effective Purchasing organization with regard to client engagement.  If not, you should start thinking about how to engage in this journey so that both Purchasing and clients can benefit from it.

– See more at: http://www.mypurchasingcenter.com/office-products/blogs/are-you-engaging-all-your-clients/#sthash.zhP660l0.dpuf