Tag Archives: IIAPS White Paper

Are Aggressive Buyers Stupid or Guilty of Segmentation Errors?

200938132350607This blog by Andrew Cox (originally posted on Spend Matters) continues the debate on procurement practices in the retail industry that have come under recent scrutiny and criticism.

In a recent blog (Spend Matters, 21st January) I explained why I disagree with Peter Smith’s view (Spend Matters, 12th January) that food companies should be condemned as ‘unethical’. I also do not think food companies have been ‘stupid’.

Nevertheless, I do agree with him (and with David Atkinson) that, when developing more aggressive sourcing strategies to extract extra value for themselves, these companies—in the face of increased competition and declining profitability—may have been guilty of some serious power and leverage segmentation errors.

It would appear that the some food companies may have rushed into decisions without fully segmenting their power and leverage positions across their entire supply base. By doing so they have appear to have developed a ‘knee-jerk’ and ‘one size fits all’ approach to sourcing.

Perhaps the gravest error that any buyer can make is to fail to properly segment their supply base, so that they can fully identify the range of power and leverage scenarios that exist (see diagram below), both within their categories of spend, and also in relation to each and every supplier within them—currently and potentially in the future.

The Power Matrix Figure

Only by understanding the current and future potential power position of each and every supplier in a category of spend, does it become possible to identify two things:

  • Which categories are likely to be the most amenable to particular types of sourcing strategies?
  • Which suppliers (if not all) within a particular category are likely to be the most amenable to successful leveraging successfully, given a particular sourcing strategy?

To put it at its simplest, if a supplier is dominant (i.e. they have a monopoly over a product/service which cannot be easily competed away, and this is highly valued by the buying company’s customers) then it is likely to be a serious error to try to leverage them aggressively within a contractual term, or before awarding a new contract. If the dominant supplier has many alternative options they can either walk away or impose unacceptably high costs on the buyer for their aggressive behaviour.

Conversely, if a supplier is operating in the buyer dominance (few buyers/many suppliers/low switching costs) or independence power positions (many buyers/many suppliers/low switching costs) then the scope to use more aggressive leverage successfully within or before contracts are signed is much greater for the buyer. This is because the buyer has many alternative sources of supply and the supplier must continue to pass value to the buyer if they wish to retain the relationship in the future.

It follows from this that buyers must be extremely careful about analysing the power position of each and every potential supplier, both now and in the future. If they do not, then they may well fall into the trap of adopting a ‘one size fits all’ strategy that can lead to serious supply consequences in the future.

In this light, although we cannot know for certain without analysing these sourcing strategies in detail, the adoption of universal approaches that demand more money for simply being a supplier (Premier Foods’ pay and stay approach), or continually asking for increased discounts after agreeing contractual prices (Tesco), are evidence of overly-simplistic sourcing approaches that have not been informed by a sophisticated segmentation of the power and leverage positions of each and every supplier.

That said there is nothing wrong with adopting a universal approach to supplier leverage in the future, but this is only likely to be safe if the power position favours the buyer both now and in the future, and all of the suppliers are operating in a relatively weak bargaining position (which of course never happens).

Given this, it could be that Sainsbury’s strategy of delaying payment terms for all of its construction and fit out contractors is a sensible strategy. But this would only be the case if all of these suppliers are highly dependent on working with Sainsbury’s, with few alternatives, and none are able to use counter leverage in the future.

It is not clear, however, whether or not food companies have fully thought through this last point—namely, the need to fully understand and segment the time dimension in power and leverage.

Obviously, while power can move between buyers and suppliers over time, it is important to recognise that this power shift does not occur in all categories of spend in the same way. Sometimes, buyers may be at risk of it, but at other times they may not. One must be careful, therefore, about claiming that suppliers will always be able to take advantage of buyers in the future if they abuse their power now, and vice versa.

Once again this forces us to recognise that a ‘one size fits all’ strategy is normally an error, and that the sophisticated segmentation of power and leverage scenarios is at the heart of successful sourcing strategy development and subsequent supplier relationship management.

Indeed, it is interesting to conclude with the thought that power segmentation within supply chains also demonstrates that the use of aggressive ‘within-contract’ (this is post-contract if deemed after contract award) and ‘post-contract’ leverage may be much easier for some companies than others.

There is another power-related factor—sourcing strategy brand impact—that buyers have to consider, and one which may be much more problematic for B2C retail companies that sell to end consumers (like Tesco and Sainsbury’s) than for B2B companies (like Premier Foods and 2 Sisters) selling to retailers. Arguably, B2C firms have to be much more aware of the impact of their sourcing strategies on public opinion and customer behaviour than others (and particularly if these are likely to be aired in the press and media).

The problem for Tesco and Sainsbury’s is that their brand reputation is a key factor in their overall business strategy, and this is because they operate in an increasingly competitive market, with new lower cost entrants challenging their historic market shares and profitability. In such a market, where the switching costs for consumers are relatively low, food retailers must jealously protect their brands.

This means that any consumer perception that a sourcing strategy is a form of ‘unethical bullying’ is likely to have a significant impact on customer behaviour, and potentially on market share and profitability. Arguably, this issue is much less likely to be a constraint for B2B companies (and especially multi-product) companies in the food supply chain.

While we have only focused here on a few power resources (and there are many more that need to be considered when developing an effective sourcing strategy), these examples highlight the fact that some food companies are evidently not fully competent in understanding power and leverage when developing their sourcing strategies.

This reinforces the view that one of the greatest weaknesses in the procurement profession today is the lack of competence by buyers in fully analysing their current and future power positions, leading to a failure to fully understand the appropriate sourcing options that are available to them to leverage improved value from suppliers.

How this competence gap can be eradicated will be a subject for the future.

The Problem With Win-Win

WP-ProbWinWinWhy the notion of ‘win-win’ in collaborative long-term buyer-supplier relationships is as misguided as it overused.

Creating mutually advantageous “win-win” outcomes is frequently considered best practice, just as partnering was a decade ago. As a result, like partnering, the win-win concept suffers from the same type of use and abuse that is likely to render it a meaningless concept.

An IIAPS White Paper challenges the view that win-win outcomes are best practice and contends that buyers seeking to achieve such outcomes are guilty of poor and misguided thinking. This is because a true win-win, in which both parties simultaneously achieve their ideal outcomes, is not feasible under any circumstances.

By its very nature, buyer and supplier exchange is always contested. Despite this, it is argued that long-term collaborative relationships are still an extremely useful tool in the armoury of a buyer seeking improved value for money.

The White Paper provides four cases which demonstrate that collaborative relationships can be highly successful for competent buyers, but a recipe for disaster for the unwary.

To some the cases may appear to be examples of win-win outcomes, but detailed analysis of these long-term collaborative relationships reveals that is not the case in practice, and that very different outcomes occur, some of which favour the buyer and some that definitely do not.

The search for a win-win is a fundamental error that can blind managers to the reality of the buyer and supplier exchange. The paper concludes by providing five steps to avoid myopia in collaborative relationships and the problems that buyers may face if they end up being taken advantage of by more commercially competent suppliers, who are maximising their own commercial and operational interests at the expense of the buyer.

All of the arguments presented in this blog are fully explained in the IIAPS Whitepaper The Problem with Win-Win.

The Causes of Major Outsourcing Failures

Outsourcing. Business Background.Many organisations are guilty of sub-optimal strategies because they do not understand the potential pitfalls of outsourcing.

Managers are faced with an avalanche of advice about what they should do to be successful. The academic and consulting management literature is replete with articles and books that provide guides to success, with many case studies explaining why a particular individual or company was successful and what practitioners must do to emulate it in their own organisations.

This is not surprising, because practitioners are keen to find shortcuts and are desperate to emulate those who have been successful. Outsourcing is no different, as it has become something of a dominant approach as organisations seek ways of improving competitive advantage and bottom-line performance.

There are, however, problems with this approach.

  1. Practitioners copying what others have done can be dangerous if the emulator is not operating in exactly the same circumstances as the originator.
  2. A little knowledge can be dangerous. A cursory perusal may allow an emulator to understand in general what the originator did, but not fully to appreciate what was required to put it into practice successfully.

Given that emulators often fail to achieve the same success as originators, it is somewhat surprising that managers do not spend more time trying to understand why. Even more so because, from an early age, human beings do not normally learn by being told what is the correct thing to do. In fact, most of us learn from experience – that is, from making mistakes.

Most of the outsourcing decisions that IIAPS staff have analysed over the last two decades have been failures rather than successes.

By understanding what goes wrong strategically and tactically in outsourcing decisions, practitioners will be in a much better position to understand how to be successful. This is a radically different approach to the normal advice that practitioners receive.

An IIAPS White Paper highlights the major outsourcing failures that we have identified:
Pre-Contractual
1. Outsourcing strategically critical assets
2. Retaining tactically non-critical assets in-house
Post-Contractual
3. Failing to understand post-contractual “moral hazard” and lock-in
4. Inappropriate post-contractual relationship management

Each of these generic problems is outlined, with case studies to provide empirical evidence of the errors that organisations make on a fairly regular basis.

The Whitepaper also provides the 10 major reasons why organisations appear to make these mistakes when outsourcing and the 5 steps to successful outsourcing.

What is clear in practice is that, despite the many thousands of words written on the subject of outsourcing, most organisations we have worked with appear to be guilty of sub-optimal strategies. This is because practitioners do not fully understand the pitfalls of outsourcing.

Effective Buying – The Hidden Costs of Purchasing

WP-EffBuyBuyers are under pressure to cut purchase price – but aggressive cost-reduction exercises can sometimes lead to sub-optimal buying. Effective buying requires the ability to manage complex, value-for-money trade-offs and to understand the direct and indirect costs and consequences of ownership.

Interest in effective buying has a long history. The Latin phrase: “Caveat Emptor” means “Buyer Beware!” It was used in Roman times to warn buyers to be wary over what suppliers offer.

In more recent times in his classic quote from 1865, John Ruskin warned buyers about the adulteration of goods and services by unscrupulous suppliers: “There is hardly anything in this world that some men cannot sell a little more cheaply and make a little worse. Those who consider price only are this man’s lawful prey.”

What each of these sayings is trying to explain is that, just because everyone regularly buys things, it does not mean that we are all effective buyers. This is because effective buying involves an understanding of fairly complex value-for-money trade-offs and the avoidance of unforeseen, or hidden costs or consequences over time.

An IIAPS White Paper explains how buyers may begin to think about value for money trade-offs between the specific performance (functionality) they receive from a product or service and the total cost of ownership of acquiring it. This is supported by a number of case examples of effective buying.

The White Paper also introduces a structure for effective buying.  This states that the challenge for practitioners is to understand the organisational processes that support sourcing best practice, and then to convince senior management of the need to resource the process effectively.

There are a number of ways in which a sourcing process can be created so that all aspects of buying can be undertaken in a rigorous and robust manner. In general terms any process must accommodate eight steps – from the initial design and specification of the requirement to its eventual market testing with suppliers, through negotiation and contract award to supplier post-contractual performance management and eventually to strategy review and knowledge management.

All of the arguments presented in this blog are fully explained in the IIAPS Whitepaper Effective Buying: The hidden costs of purchasing.

When are World-Class Sourcing Practices More Important?

A previous blog highlighted the need to differentiate between world-class and best-in-class sourcing practices.

Our extensive benchmarking studies, using our PSCM Index, have allowed us to arrive at an understanding of why certain organisations in particular sectors tend to be seen as exemplar cases of good practice.

It is a combination of a number of factors. Organisations that achieve scores close to ‘world-class’ performance tend to operate in process-based industrial sectors, where high volume and frequent demand allows the adoption of leading edge demand and supply management practices. They also tend to be organisations that are heavily outsourced and make relatively low returns.

World-Class Sectors Chart

In quadrant A in the figure above, adopting ‘world-class’ PSCM processes & systems is unlikely to be seen by senior managers as of much value. Complex PSCM tools and techniques are not high on the agenda, as profits are normally high and the need to reduce costs is low.

This contrasts sharply with the situation in quadrant D where profit margins tend to be low, and most of what is provided to customers is sourced from external suppliers. In these organisations the role of PSCM is critical to corporate success and it is hardly surprising, therefore, that most of the organisations that tend towards ‘world-class’ are to be found here. The Automotive, Retail & Consumer Goods/FMCG sectors tend towards ‘world-class’ performance in procurement because they must leverage external resources for competitive advantage and as a matter of survival, not just because they are better managed than others.

Our benchmarking studies show, therefore, that not every organisation can, or needs to, adopt the same practices as others. Given this, while it is sensible to know where an organisation stands in relation to current ‘world-class’ best practice (the ideal), managers need to understand which practices are ‘best-in-class’ and feasible and appropriate within the sectors in which they operate.

All of the arguments presented in this blog are fully explained in the IIAPS Whitepaper Beyond Kraljic.

World-Class or Best-in-Class?

WP-WCorBICFor benchmarking to be meaningful, you need to be clear about both the performance level you are aiming for and what is feasible in your sector.

Most senior procurement executives want to know how their organisation compares to others in their possession and use of the available operational processes and systems that support ‘good practice’. While this sounds straightforward, understanding what is ‘good practice’ for a specific organisation can be problematic. This is because managers often struggle with definitions of ‘world-class’ and ‘best-in-class’ performance. Are they the same?

An attempt is made in an IIAPS Whitepaper to shed light on these issues.

The general thrust of the argument in this document is that the concept of ‘world-class’ can only be useful if it is seen as a moving ‘ideal’ that is unlikely to be fully achieved by any organisation, but against which public and private sector organisations (operating within particular circumstances) can compare themselves.

This definition makes it possible to understand what ‘best-in-class’ means — the current performance of an organisation relative to both ‘world-class’ and other comparable organisations. This comparison may be against organisations in the same industrial sector, or those of similar size in terms of revenues or number of employees.

The argument is supported by evidence from benchmarking studies into organisational competence in Europe, the Middle East and the US. The evidence shows that some organisations and sectors perform better than others, but also why it is that they should be expected to do so.

Not every organisation can, or needs to, adopt the same practices as others. What organisations and their managers have to understand is which practices are ‘best-in-class’ (i.e. ‘optimal’) for them in the context in which they find themselves. Put simply, organisations need to understand what is the most appropriate thing to do in the context of their sector, market and supply chain
circumstances.

The arguments presented in this blog are fully explained by an IIAPS Whitepaper World-Class or Best-in-Class?