Global Leaders in Procurement & Negotiations (PSCMInstitute.com)

Author: OmidG

  • Do You Cost Model? Why Not? Part V

    Supply Chain Management Training

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  • Do You Cost Model? Why Not? Part IV

    Supply Chain Management Training

    “These activities have to take place. If you don’t do them, you are making yourself irrelevant in the field of purchasing. “

    Purchasing & Supply Chain Management TrainingSo we’re on a multi-part series about cost modeling. We’ve already covered why cost modeling is important, and why cost modeling MUST be a part of your arsenal, an area where you have strength and an area in which you excel.

    It’s funny, I was reading an article this last week, one meant to give deep insight to negotiation strategies, one piece at a time. The advice given in this last piece was to make sure that you (the purchasing professional) arrive at the negotiation room after the supplier, to give the illusion of being important.

    I get frustrated reading this kind of stuff. I really do. Hello, this is not 1978 anymore. Do you really think that in the supply chain management model that we are trying to move towards that supply chain partners plan and perform such ridiculous gimmicks against one another?

    Make it stop.

    Achieving lowest TCO is not about psychological warfare or “getting what you deserve” or trying to act really important, it’s about building a case through data and using influence techniques that motivate the other party (not scare, intimidate, or make them paranoid). Period, end.

    We said that should cost modeling would be used when the goods are service are unique and cannot be benchmarked or put out to bid, and that must cost models should be used when fair market value by any analysis far exceeds available budget.

    So now let’s move onto Total Cost Modeling. Total cost models should be used when post acquisition costs are a substantial portion of total cost.

    We’ve all made this mistake before. I always refer back to the mistakes from very early in my career. Remember, you always learn more from your mistakes than from your successes. I once negotiated a killer deal on a large software contract. Every single aspect of what was being negotiated; I nailed it all.

    However, I turned around a year later and found out that our spends with the supplier went through the roof. How could this happen? Well, the end user spent well over $100K with the supplier in consulting and training costs for implementation! How come nobody told me about this when we were doing the SOW?

    It’s not the customer’s fault. It was my fault. Remember, the customer wants to buy goods and services. You are supposed to be buying PERFORMANCE RESULTS. You have to ask all the questions. A critical component of TCO was missed. And it happened AFTER the goods were acquired.

    Fast forward to another negotiation I worked on. The company stock price was through the roof, and we were considering buying a fleet of jets. Good times. Anyways, the cost model I put together showed that, on a pure cash flow basis, it was cheaper to have employees keep flying commercial. Management was satisfied and wanted to put the idea to bed.

    However, I said I wanted to do a total cost model as well. Everything changed. The reason? It turned out that flying commercial meant longer drives for employees, more unproductive airport time, and most importantly, it necessitated rental car expenses and overnight hotel stays for what should have been day trips.

    I did a study of the average time savings of going to the nearby private airport and also on how many trips based on real data could have had rental car and hotel expenses avoided. The figures were staggering. It became a no-brainer to get the jets.

    Acquisition price vs commercial flight costs painted a different picture however, and none of this was clear until post-acquisition costs were analyzed.

    I worked with a company that made the decision to outsource some of their operations. They had a cost model that showed costs of outsourcing, and the numbers made sense. However, I told them that this was an incomplete analysis. And it was.

    You see, most companies aren’t very good at outsourcing. They want someone else to do the work, but they don’t want to let go of the work at the same time. So they kept a large staff still focused on the outsourced function, and also incurred frequent travel back and forth to the outsourced company.

    Once I guided them on how to calculate the REAL cost of their outsourcing model, they were left wondering why they ever outsourced in the first place. The problem is, they didn’t account for post-acquisition costs.

    There are so many factors that can come into play with total cost modeling. You have to fully comprehend implementation with the good or service being purchased and then assess what post acquisition costs may be incurred. Here are some of the types of costs to look at:

    Warranty, maintenance, obsolescence, scrap value, resale value, training, consulting, insurance, utilities, switching costs, sunk costs, opportunity costs, controllable costs, uncontrollable costs, administration, personnel, travel, and there are still many others.

    Then, as stated before, you need to label all your data sources and classify each data point as a fact, estimate, or assumption, following which sensitivity analysis should be performed on all estimates and assumptions.

    These activities have to take place. If you don’t do them, you are making yourself irrelevant in the field of purchasing.

    Next week, we will talk about benchmarking. Keep reading and try to apply these concepts.

    I also offer in depth courses and seminars on these topics that will catapult your departmental capabilities and results to the next level. Contact me any time if you want to find out how to make your purchasing department world class.

    Side note: Pretty soon, I will make an announcement that will shock you all, and will dramatically change the purchasing and supply chain management landscape as we know it.

    Stay tuned.

  • Do You Cost Model? Why Not? PART III

    Cost Modeling Purchasing Training

     

    Purchasing Training - Cost Modeling
    Purchasing Training – Cost Modeling

    OK, so we’ve talked about the importance of cost modeling and why this is something you must be good at as a purchasing professional.

    I’ve consistently seen that purchasing professionals want their finance people to do cost models and want their legal people to do contracts. These are career killing practices. Cut it out!

    These are golden opportunities to make strengthen your arsenal, show that you defer to no one when driving aggressive TCO solutions, and that you understand every facet of what it is you are negotiating. Suppliers know when you don’t know. And they love it.

    So we covered Must Cost Models last week and we will talk about Should Cost Models this week.

    A should cost model is used when the product/service being purchased cannot be benchmarked via an RFX process (due to uniqueness of what is being purchased), and therefore the method of choice is to break down suppliers costs and find out what it “should cost” to be providing this product or service… hence the name.

    This can be a great tool in negotiations. In an era where supply chain management is coming, putting things out to bid will happen less and less. Instead, you will be collaborating with suppliers in the supply chain with whom you have long term relationships to identify joint cost opportunities. Getting good at should cost models will greatly ease this transition.

    The first guy who trained me in purchasing had no idea what he was doing. And he’d been at it for years. This was in a Fortune 50 purchasing department mind you. We had lots of accolades on the outside and lots of inept practices on the inside. Sound familiar?

    I was negotiating a consulting agreement for unique services. That means that benchmarking was not an option (we’ll talk about benchmarking next week). Budget wasn’t overly constrained, so a must cost model wasn’t appropriate either. We needed to do a should cost model.

    So Mr. Trainer had me do a cost model that looked at how many employees this consulting company had, what types of employees, how many computers they had, how many fax machines, what the square footage of their building was, and so on.

    I then had to determine what each of those employees should be getting paid, what the cost of the hardware they had was, and what the cost of real estate was in that area. Then I added on insurance costs, burden rates, and many other extraneous pieces of financial information.

    The net result? A multi-page spreadsheet that that couldn’t help me close a car door, much less a negotiation. It took two full weeks of my life – that I’ll never get back – to gather that data.

    A should cost model was the right tool, but the right tool can be used wrong. What I should have done (or rather, what Mr. Smarty Pants should have told me to do) was something far more basic:

    Let’s assume the consultant wanted $400/hour. I should have taken the consultant’s resume and shown it to the internal customer and ask “what would you pay this person if you were to hire them as a full time employee?” Let’s say the answer was $110K/year.

    Now I just need a few more piece of information: burden rate, consultant utilization rates, and industry average profit margin. Burden rate (the costs of an employee beyond cash compensation – insurance, cubicle, 401K contributions, etc) is usually 30%.

    Consultants usually have only about 50% of their time as billable. Anything less is a red flag. Anything more, and they aren’t spending enough time researching and ensuring they are at the top of their game.

    Then if I were to look up the NAICS code for the consultant ( you can ask any supplier what their NAICS code is – it is 6 digits and you can then research financial averages for that industry), their profit margin would probably be about 50%. Consultants have high profit margins.

    The average employee works 2,000 hours a year – a nice round figure. We will cut this in half though, due to billable time by consultants in the average year.

    So let’s do the math:

    $110K + 30% burden rate = $143K, which is the cost of hiring that consultant as an employee. It doesn’t matter that neither party is proposing to do this.

    $143K + 50% industry average profit margin = $286K (I know you think it should be $214.5K – this is a common financial modeling mistake), which is what the consultant should then expect to gross in a year if both burden rate and industry average profit margins are included.

    $286K/1,000 hours = $286/hour, which gives you a benchmark rate to work off of in should cost model based negotiations.

    The argument is “if we were to hire you at market rate, and to add on burden to address all costs, and add on industry average profit margins for your NAICS code, and even assume only a 50% billable rate per year, we would still be at $286/hour vs the $400/hour you are asking for. Help me understand the data here, because my analysis points me in a different direction that what you’re charging.”

    If you don’t think this works, you are dead wrong. The supplier will be stuck. You will have painted them in a corner. The data does all the talking. And compared to all the useless analysis I did before, this was a walk in the park.

    I would like to run through many more examples, but it’s just not practical in a blog. The point is, you have to negotiate with data.

    The first choice is benchmarking in most cases. If that is not available or feasible, then you move onto Must, Should, or Total Cost Modeling.

    Suppliers hate it when you negotiate with data and they love it when you don’t.

    Stop believing that just taking a negotiation class that teaches you how to influence with behavioral techniques is all you need. That only works in glossy airplane magazine advertisements.

    You have to couple those techniques with in depth data analysis, and *only then* can you make a case for negotiation success.

    Feel free to contact me if you want world class TCO training for your organization. Just don’t use any of the techniques I taught you above when we talk price!

  • Do You Cost Model? Why Not?

    Procurement, Purchasing & Supply Chain Management Training

     

    Procurement training, purchasing training, supply chain management training, cost modelingLast week I wrote about cost modeling as an overall activity that all purchasing professionals MUST be good at. A lot of purchasing professionals tell me “I have a really good finance department and they do all of our cost models.” 

    This sounds great, but it’s a huge disservice to your investment in yourself, your career, and your results when you fail to develop cost modeling skills in this profession.

    It’s not something you can have the finance department do for you. You have to be the one doing them.

    Having the finance department do cost models for you is like a pilot asking some other employee to do takeoffs and landings for them. It’s a showstopper. Even worse than that though is not doing cost models at all!

    This week we are going to talk about Must Cost Models. This is one of the most underrated and misunderstood types of cost models.

    There are certain times when your customer just doesn’t have enough budget for the good or service that they need. It happens.

    In some cases, the budget is actually less than fair market value for what you are trying to buy – meaning, it would require a win/lose “sock it to the supplier, hard” type of negotiation to get the customer what he or she wants for the amount of budget that they have.

    That is not a good approach. Even though many of the negotiation courses out there are proponents of maximizing personal gain in negotiations, suppliers will be bitter after such negotiations, and they will nickel and dime you to death until they make their money by the end of the deal.

    So no level of benchmarking or other type of cost model will do. The one very powerful tool at your disposal is what’s called a “Must Cost Model”. This means that you do the unheard of – you make your position completely transparent, and you tell the supplier your problem and tell them your budget.

    You heard me right. The cardinal rule of “never disclose budgetary availability” has an exception, and this is it.

    When the available budget is less than the most aggressive assessment of fair market value, then you should look at disclosing your budget to the supplier. Your budget is what the supplier’s quotation “must cost”, hence the name.

    What this does is a few things. First off, the supplier will appreciate your position. If the fair market value for a piece of capital equipment is $320K and you have $200K budget, a negotiation position of $200K may actually make the supplier angry, because they will perceive a win/lose agenda.

    However, if you disclose that your budget is $200K and ask them for their help, then the supplier becomes a part of the solution.

    This is where the real breakthroughs can happen. Remember, suppliers are a lot smarter than you are regarding total cost. They sell that product or service ALL DAY LONG to an entire planet full of customers.
    You are just negotiating this contract a couple of times a year at best, and probably a lot less than that.

    The types of breakthroughs that can come about are things such as the following collaborative cost reduction ideas, in return for reduced supplier pricing that is closer to your “must cost” requirements:

    • Use of a different type of material
    • Different lead time and shipping requirements
    • Substitute components
    • Buying fewer of the items but still meeting customer requirements
    • Switching from custom components or services to standard goods and services
    • Having less “bells and whistles” on goods being purchased
    • Simplify services model and scope of work
    • Paying earlier to secure a better price
    • Making an aggressive early payment before the end of the supplier’s fiscal cycle
    • Adopting specifications or SOW components from other customers of the supplier that reduce cost

    The list goes on and on. My favorite example is that a client of mine was working with a PVC supplier to try and do a must cost model, based on my guidance. I helped them with the supplier engagement.

    It turns out that we were able to slash 40% off of the PVC costs, getting down to our Must Cost Model requirements.

    How did this happen? Well, the specs required that the clients name be stamped on the pipe every 3’. This pipe was going….. underground.

    The supplier made this kind of pipe all day long, but in order to meet customer requirements, they had to have separate procedures to stamp the pipe.

    A standard product became a custom product, and this added cost. Had we just negotiated for lower prices, maybe we could have gotten 10% lower. And that would mean the supplier makes 10% less, because the costs don’t change.

    However, when you do must cost modeling, you can dissect costs and find innovation and breakthroughs that benefit both parties, while still meeting budgetary requirements. We used it carve 40% of the price, and my client was buying miles and miles of this product!

    If you are not doing cost modeling, you need to start. It is not an optional skill set or purchasing process step. It is vital to your career, your results, and ultimately, your income in this profession.

    I offer in depth cost model training – a full 8 hour course in fact – to companies who are interested in private seminars, and also in private coaching sessions as well of course. I also have a 7 hour cost modeling video coming out soon. Look for it!

    Next week, we will talk about Should Cost Models. See you then!

  • Do You Cost Model? Why Not?

    That’s one of the questions I’m going to ask at a 2 day public seminar I’m leading in Singapore next month. If you look at all the negotiation courses out there, they all focus on ways to influence suppliers to achieve your objectives.

    None of the negotiation courses out there, and I really truly mean none of them, talk about cost modeling.

    Is this a problem? Well, of course it is. Imagine going to a car dealership to buy or lease a new car and not having performed any kind of number crunching beforehand. All you have in your bag of tricks is a series of behavioral influencing techniques. Don’t you think that would put you at a gigantic disadvantage?

    Mind you I’m not saying that influencing techniques aren’t important. They’re critical and indispensable. What I’m saying is that if that is all you’ve learned and practiced when it comes to negotiations, then what you have is an incomplete strategy.

    The foundation of all purchasing negotiations is data. Either you’ve done your homework and analysis or you haven’t. No amount of behavioral influencing techniques, as effective as they may be, will make up for this.

    Some of the most tested and true data based negotiation techniques are must cost models, total cost models, should cost models, and benchmarking.

    Should cost models are used when custom product/service or sole sourced providers are being assessed. The reason for these cost models is that there is no other way of assessing whether or not TCO is being optimized, due to the custom or sole source nature of the purchasing scenario.

    Must cost models are used when you KNOW that price exceeds budget under all scenarios. This is the one and only time in negotiations where it is to your advantage to disclose budget. This can result in tremendous innovation and breakthrough, because it forces reassessment of cost drivers to hit new price targets.

    Total cost models are used when there is a material difference between acquisition cost and total cost. This is critical when making a lowest price decision can be counterproductive from a TCO perspective. Post acquisition costs are often ignored or misunderstood in purchasing decision making, and that’s where total cost models ensure that the right TCO decisions are made.

    Benchmarking is best used for undifferentiated products/services where apples to apples comparisons can be performed, usually through an RFX process. Using industry available benchmarking information is often less reliable, unless it is a TRUE commodity item, such as copper, oil, or other traded commodities.

    For any high value negotiation, one of the above cost modeling techniques must be performed, and the right one must be used. There are also lots of rules for doing cost models, from differentiating between facts, assumptions, and estimates to doing sensitivity analysis with key variables to change control techniques. You also have to understand the various types of costs, such as fixed, variable, average fixed cost, opportunity costs, sunk costs, switching costs, etc.

    I’ll never forget my first negotiation ever. I had all my influencing techniques down. I was confident and ready. I told the supplier, who had everything to lose, that I wanted and expected an 18% discount, up from the 15% we were getting previously. I used every negotiation influencing technique I had studied.

    The supplier had one response: “Why 18%? Why not 20% or 25% or 27%?” I sat there like a bag of potatoes. I literally had no response. He caught me. I didn’t do cost modeling. Nobody taught me cost modeling. I had no data based negotiation strategy upon which to rest my case.

    I don’t remember the outcome of that negotiation (it was probably suboptimal), but I will never forget how I felt. Never again would I go into a negotiation without having done cost modeling.

    Are you doing cost modeling for all of your major negotiations? Does your analysis lead you to the lowest TCO answer? Do you know what type of cost models to do and when? Do you follow all the cost model rules above and do sensitivity analysis on your findings?

    If you ever ask yourself “could I have done better in that negotiation?” Cost modeling helps eliminate all doubt, and shows to management and customers that you got the best possible deal for your company.

    Make it a part of your arsenal, be a complete purchasing professional, and put your results and career on the fast track to success. Being good at cost modeling is one of the most confidence building skills you can establish in our profession.

    Contact me if you’d like to get cost model training or have an in-house seminar done for your organization. I’d love to partner with you and help jump your TCO results into high gear.

    SPECIAL ANNOUNCEMENT! 

    I’ve just released my latest book, “World Class Contract Management – The ULTIMATE Reference Guide For Purchasing Professionals“

    Click Here To Get Your Copy Now!

    This book is intended to give an overview of the highly critical skill of purchasing contract management (or what sales professionals would call ‘sales contract management’).

    Purchasing professionals are consistently plagued by inadequate knowledge of purchasing contract law, which becomes a capability and therefore a career liability. The goal of this book is to address this problem and turn this liability to an area of strength and competitive advantage for purchasing professionals.

    This book is intended to be a timeless reference guide, and is written for the practitioner – the person who wants concrete and actionable direction to do their job better and get their career on the fast track. The importance and purpose of contracts is covered, followed by how to customize purchasing contracts to fit the purchase, and then a detailed (116 pages) coverage of all major contract clauses, what they mean, and how to negotiate them.

    The book closes out with best in class post contract management practices. 

    Become world class and a leader in your company and our industry. You’ll be glad you did!

    Click Here To Get Your Copy Now!

  • Are You Watching Your Customers? This Will Get Your Attention!

    I just recently had lunch with one of my business partners. He’s a sales executive for a major IT company. He was telling me that in his sales positions for the various companies he’s worked for, his customers (I’m not talking about purchasing mind you, I’m talking about the internal customer who is generating the demand) would regularly call him and casually invite perks.

    The conversations would go something like this (I’m using the name Mike – not his real name): “You know Mike, my department gave you $3 million in spends last year. There’s a 1 hour course I want to take in Honolulu, can you set me up for that? Also, I want to take my family, and I want have about 3 days before and 3 days after the course to adjust for jet lag. Can you do that for me?”

    And you know what? He would! He’d fly their entire family over to Hawaii for the week, all expenses paid. He didn’t just do this kind of thing once, it was a regular sort of deal with all of his biggest customers.

    Another big customer of his would always want to hit the town and run up celebrity like bills at the most expensive restaurants that money could buy. He was game.

    You see, you and I know that purchasing department personnel go through rigorous code of conduct training to avoid not only conflict of interest, but even the false perception of conflict of interest. That means purchasing professionals typically can’t accept any gift unless it’s both less than $25 AND has the supplier’s logo on it.

    However, if you venture into your own company’s sales department, you will find that they are being trained and funded to engage in these exact same activities that they are telling purchasing not to do– to wine and dine the customer to develop continued allegiance and, therefore, continued revenue. They WANT the customer to develop a conflict of interest.

    Every single company talks out of both sides of their mouth in this manner. One pitch is for the purchasing department, and the other pitch is for the sales department. It’s a fascinating dichotomy, and it invites all sorts of questions about ethics.

    So who squeaks under the radar in all of this? Your internal customer. The big focus is on purchasing, and making sure purchasing isn’t engaging in such activities. But who’s policing the customer? Do you know if your customer is accepting such gifts? It might be against company policy, but it’s not against the law. And the supplier is more than happy to do it. That’s what their customer budgets are for. They’re expected to spend it.

    I personally have witness countless purchasing professionals get fired due to a conflict of interest. One got fired because he accepted tickets to a golf tournament and went with the supplier. He was one of the best, but it wasn’t tolerated. Another got fired because he had his landscaping supplier start doing his property too. All eyes are on purchasing, but who’s watching the customer?

    Suppliers know the game. They keep this stuff quiet. A dog never bites the hand that feeds it, and everything that suppliers are taught centers around pleasing the customer. Nowhere in their training does it say to please purchasing.

    So be aware. The question is, have you set expectations with your suppliers? Have you told them, in writing, that they may not give gifts of greater than $25 to any employee of your firm, and than any such gifts must have their logo on them? Better yet, have you put this into your contracts, so that failure to perform becomes a breach of contract , and therefore a performance issue?

    There’s more to this than just conflict of interest. We all know how customers try to force particular suppliers on purchasing. Now you have to dissect and understand the business drivers. If there is competition and the customer doesn’t want it, then you need to dig deeper. Left unchecked, this can end up causing your TCO proposition to lose value, because something other than TCO may be used as a supplier selection criteria by your customers.

    Pay attention, and don’t fool yourself into thinking this only happens in countries where corrupt business practices rule. It happens here and it’s probably happening in your company. Take preventative measures and don’t wait until something happens – because you’ll probably never figure it out anyways. Everyone involved keeps it quiet.

    Set expectations with suppliers and the internal customer and be accountable for the results. As corporate stewards for how the company’s money is spent, this is your obligation to the board of directors and the shareholders of the company.

  • Purchasing TCO Strategies are Changing – Are You Ready?

    I was doing work for a client last week on the East Coast. Someone there asked me if today’s strategic sourcing strategies are here to stay. My answer caught her off guard. “Absolutely not” is what I said. In fact, I think we are mostly behind the curve.

    Before I get into why, I really do have to acknowledge all the progress made in our profession. We’ve gone from expediting purchase orders (1970’s) to driving a wealth of strategic TCO oriented strategies today. “We’ve come a long way, baby!”

    However, what I still see is that even the most sophisticated purchasing strategies are largely predicated on using influence, economies of scale, and competitive practices (all really good things, mind you) to get suppliers to lower their prices.

    What’s not to like? Well, getting a supplier to lower their price, all other things being equal, means they need to lower their profit margins. That’s really what it boils down to. They are willing to do it in the right circumstances, and it can still be a win/win deal.

    Still all upside for both parties, right? Not necessarily.

    My big issue is this: when you focus on reducing supplier profit margin, no matter how sophisticated your strategy is, all you are doing is pushing costs down the supply chain. You haven’t really improved the supply chain in any way.

    There are an entire supply chain worth of costs that can be assessed, and that is really the next big breakthrough we have to make it to as purchasing professionals.

    Here’s the thing though. You read articles about supply chain management and it is so daunting, so unwieldy, so complicated that you just don’t know what to do differently when you get back to your desk.

    That has to change. There are simple things that we can and should be doing that don’t require sophisticated tools, systems, or supply chain expertise.

    You see, suppliers are unfortunately taught that “the customer is always right”. Sounds good, except what this means is that when your internal customer produces a SOW or Spec that wasn’t designed for TCO, your supplier won’t say anything.

    It also means that everything you specify as a part of your manufacturing and service requirements will be adhered to 100% – even if it is unnecessarily adding a tremendous amount to your cost proposition. Why? Because “the customer is always right.”

    So we need to start looking at opportunities to take costs out of the supply chain. When you take a cost out, it’s gone. You haven’t pushed them anyplace. Assuming you didn’t cause some other TCO problem, you have actually made the supply chain better.

    Here are some examples you can look for now (I took this part from a longer article I wrote that’s being published in an ISM journal later this month – I encourage you to look for it and read it):

    Redundant costs: Supplier is doing outgoing quality inspection and supply manager is doing incoming quality inspection; both parties are insuring shipments to supply manager.

    Excessive costs: Expedited shipping instead of standard shipping; products or service comes with unnecessary functionality or features (“bells and whistles”) that customer doesn’t need to fulfill business requirements.

    Unnecessary costs: 5 year warranty on products that have 3 year obsolescence (such as PCs); 24 x 7 customer support model for an 8 x 5 business.

    Costs that can be eliminated: excess supplier inventory buildup due to infrequent or inaccurate forecasts from supply manager; setup costs associated with custom requirements that could be eliminated by using standard parts or processes instead where possible.

    Challenge yourself to see if you are truly driving innovation with your suppliers to take costs out of the supply chain, or if you only using sophisticated techniques (or worse yet, unsophisticated techniques!) to get suppliers to lower their price.

    We want to have our careers grow and prosper in the field of purchasing. This means doing things better than how you were taught. Leap forward and into the opportunities that await with supply chain cost analysis.

    It really is an opportunity to take your capabilities and your career to the next level.

  • PROCUREMENT TRAINING ~ Are Your Suppliers Changing Your TCO Value Proposition?

    Procurement Training TCO
    Watch Those Sneaky Suppliers!

    One of my great joys is to go out to my orchard and take care of the trees, eat the varying fruits, and enjoy the shade the trees provide as well. I have about 100 or so fruit trees of varying varieties that I planted years ago. I give to them and they give back to me. It’s a great win/win deal.

    I don’t know if any of you remember how much better supermarket fruit tasted in the 1980’s (keep reading, we’re going to talk about TCO in a minute). Take the example of apricots. They used to be soft, aromatic, juicy, and flavorful. You could smell the aroma before ever biting into them. What happened?

    Now when you go to the store, the apricots look as good as ever – beautiful color yellow with a tinge of red. The taste though. Let’s talk about the taste. Hard, no smell, no juice, no flavor. Something happened, and it’s not your imagination. It’s all about TCO. The suppliers have pulled a fast one on the buying community.

    You see, up until the late 1970’s, farmers planted a variety of apricot called Royal Blenheim. It had this great taste, flavor, texture, and aroma that consumers loved. But this wonderful fruit had TCO problems.

    Their softness and juiciness resulted in a high damage rate in shipping (not to mention birds pecking on them while still on the tree). It also resulted in them going quickly bad at the supermarket, resulting in a low shelf life. The selling community was giving buyers what they wanted, but they weren’t making enough money.

    The suppliers decided to fix the problem. No more Royal Blenheim apricot trees were planted again. They were all replaced with varieties called Tilton and Patterson. Tilton and Patterson were both very high producing trees of hard, dry, non-aromatic long shelf life, very wonderfully colored apricots. Birds hated them too.

    And these fruits had a wonderful TCO for the suppliers, because buyers (consumers) didn’t realize that their VALUE proposition had changed. The problem is that buyers were looking for two things: appearance and price. The appearance of the fruit actually improved, and the price didn’t change.

    The suppliers arranged for a win/lose deal. Profits on apricots increased and thirty or so years later, consumers (the buyers) still haven’t figured out what hit them.

    This doesn’t just happen in the agriculture industry. I’m just using this example because I know all of you can relate to it. It can happen in ever contract you sign up to with a supplier.

    Don’t ever forget, all of your suppliers are in the business of making profit. That’s their job. Therefore, they are always looking for ways to change the TCO value proposition.

    I see so many purchasing professionals that write their contracts in such a way that allow or worse yet -even encourage – the supplier to find creative ways to cut their costs while not breaching the contract.

    I focus a great deal in my seminars, personal coaching, group coaching, and consulting efforts on ensuring that purchasing organizations and purchasing professionals are buying PERFORMANCE RESULTS instead of goods and services.

    When you write a contract to be buying goods and services instead of performance results, you are *encouraging and inviting* TCO value proposition change. When you include measurable performance results criteria in the contract, you are making the supplier on the hook to make sure the value proposition doesn’t change, or even improves.

    For instance, if you write a janitorial contract that only states how often particular activities need to be done, the supplier can make their own interpretations of minimal resources (personnel, chemicals, procedures, etc) needed to do such activities in order to minimize costs.

    They can be in full compliance to the contract, and you might still not be happy at all! The reason is that you bought services instead of performance results. If you inserted measurable contract criteria for what it looks like when they are done cleaning each area, then you have prevented the supplier from changing the value proposition.

    You will have forced them to provide you with performance results instead of just simply services.

    Are you writing your contracts in a way to encourage supplier profit maximization? Have you documented your TCO value proposition and turned those into contractual supplier performance results criteria?

    If you are not careful with how you define the value proposition in your contracts, then you are letting the supplier determine how to minimize scope and maximize profits, all while staying in compliance with the contract.

    What you want is to enjoy the sweet fruits of TCO, but it doesn’t come easy. You have to exercise diligence in how you write your contracts. As for enjoying sweet juicy apricots again, I’m afraid you’re just going to have to plant your own tree.

    BTW, please connect with me on LinkedIn at: www.linkedin.com/in/omidghamami/ I always try to answer questions and help when I can.

    SPECIAL OFFER! Learn The Secrets To CATAPULT Your Purchasing Results, Career & Income Potential… GUARANTEED!

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  • Procurement Training ~ Supplier Nibbling

    Procurement Training
    Look Out For Supplier Nibbling!

    I took a long weekend and went to Carmel and Monterey with my wife and brother in law.  I just love the California Ocean.

    I have to admit though; it was pretty hard shifting from 62 ° weather back to 92 ° when we got home to Sacramento.

    Anyways, we stopped at the Strybing Arboretum in San Francisco on the way back.  It’s been free my whole life and now they charge $7 admission.

    Also, parking in SF used to always be free on Sundays and now Sundays cost money too.

    Finally, a few years ago, a 3 – 4% healthcare surcharge has been added to most San Francisco restaurants.

    My dad told me that he remembers when there was a 25 cent toll charge introduced on the BayBridge in the 1970’s, and it was announced as being “only temporary”.

    My intention is not to complain, I still love SF and these costs won’t deter me from enjoying it.

    My intent is to convey that it’s easy to miss costs when they come in little bunches from different places.   You’ll hear people complain a lot more about a sales tax increase than about any of these other costs.

    This reminded me of what suppliers do as a negotiation strategy:  “nibbling” is what they call it.  They find little ways that fall below purchasing’s radar to keep increasing their financial gain from a transaction.

    Suppliers are trained how to do this really well.  They keep your attention on price and they nibble elsewhere, both during and especially after negotiations.  You think you’re done negotiating, and from their perspective, it never really ends.

    Nibbling can be done in the form of charging you more for lesser items (bells and whistles) that you may not be focusing, or charging you for something that would normally come free.  We’ve all experienced it.  I remember once when a software supplier tried to charge us maintenance fees for our backup servers.  Nobody pays maintenance for software on backup servers, but it was an attempt on their part to nibble.

    Suppliers nibble in different ways.  They can slip the nibbling charges into other parts of their proposal, separate from their main pricing proposal, hoping you won’t see it.  They can introduce it as a concession (“ok, we’ll do that for you, but how about you guys cover ________”).

    Or they can introduce it later, through phone call or email agreements with the end customer, who may view it as a benign concession that does not affect purchase price.

    My wife attended a timeshare presentation recently in Cabo San Lucas, Mexico.  Honestly, I’d rather have a highly invasive proctology exam than go through one of those. I warned her, but sometimes you just have to experience things on your own.   Based on her subsequent assessment, it’s probably the last one she’ll attend as well.

    In any event, those presentations are a great example of supplier nibbling in action.  They talk to you about the cost of the timeshare, but they spend little time talking about maintenance and cleaning costs that get allocated to you.  They won’t even show you the contract Ts and Cs unless you’ve already agreed to buy one (if you don’t believe me – ask them for a copy of their contract during a timeshare pitch – they won’t give it).

    I have nothing against timeshares or timeshare owners, I’m just pointing out that this is another business model where part of the revenue stream is generated through creative nibbling. You have to really be paying attention or you might miss a big TCO component.

    Are you anticipating and recognizing supplier nibbling tactics?  Are you capturing the financial consequences of nibbling in your negotiation cost models?  Do you scour supplier RFX responses for nibbling?  Have you educated your customers on supplier post-contract nibbling practices? 

    It’s our job as purchasing professionals to have a mastery of TCO.  A big part of that is to make sure there is no nibbling going on by the supplier.  If we do agree to some ancillary charge, it has to be a conscious decision and it has be part of a deliberate TCO strategy on purchasing’s part.

    If you have any nibbling stories, please post them here, we’d love to hear them.

  • The Most Powerful Little Word In Purchasing

    Ask to Reveive
    Ask to Receive

    I bought my wife a new tv for her recent graduation. She got her Bachelor’s degree in Business Administration. I’m really proud of her. I want her to become a purchasing professional. Unfortunately, she doesn’t, but I won’t tell anyone if you don’t.

    Anyways, when I was a kid, all you needed was an antenna for this TV to get some reception. And some aluminum foil. And a wire coat hanger. And a martyr to hold the antenna for maximum clarity while you watched. Nowadays, all of that is woefully insufficient. We needed to get our dish service connected to this TV, which of course requires appointments…. and costs.

    There were two appointments needed. One to change out our satellite dish (we were changing our channel package), and the other was to connect the new TV to the dish service. From a purchasing perspective, it really bothered me that two appointments were needed. I asked the first technician if he was qualified and authorized to do both jobs, and he said “yes”. I asked him “well then, why don’t you save your company some money and do both jobs right now then?” He looked at me like I was a box of rocks and said “we don’t do it that way”.

    This kind of stuff drives me crazy. I want to take the CPO of this company to lunch and tell him or her how much money they are flushing down the drain with this practice. Then I’m going to make him or her pay for the lunch, just to remind them what money leaving their wallet feels like. (note to self: if they go for it, next time go to a fancy restaurant)

    Anyways, the technician visits were $150/each. The satellite upgrade was $125. I also needed another remote, that was $20. Are you keeping track? That’s $445 so far. And then the upgrade in channels was an extra $20 a month. It was part of the graduation gift to my wife – the gift that keeps on giving (ask me in 6 months if I’m still getting credit for that though, LOL).

    So we have $445 in fixed costs and $20/month in variable costs. Do you know how much I paid? Nothing. I got all the fixed costs waived, one by one, and I got the first 6 months of the variable costs waived. The only thing I agreed to pay extra was for four months of maintenance services, for a grand total of $28. That was my “big” concession. Why would they care about $28? Because it is an annuity, and many people just forget to cancel it.

    That’s not the reason I got the discounts though. The actual reason is really simple: because I “just asked” for it. I went through each cost line item and asked them to waive the costs, with an intonation that indicated that I fully expected them to do so. I used a technique that sales people use, called a presumptive close. I assumed they would do it when I asked. And they did!

    The “just ask” strategy is not new, but it does help to increase the TCO proposition. Years ago when I was a purchasing executive for Intel, I told my staff of purchasing managers that I wanted the transaction order placement personnel to start asking for extra discounts when they were placing purchase orders with suppliers.

    The response was “we’ve already spent all this energy using benchmarking and cost models and bidding to get suppliers down to their rock bottom position. An administrative personnel with no negotiations experience is not going to get it lower.

    My perspective was, if the supplier is already going to be on the phone anyways validating order information, what’s the damage in asking for an extra discount while we’re already talking to them?

    Guess what happened? It worked! Close to 50% of suppliers threw the transaction placement person a bone in the form of a slightly larger discount or an early payment discount, or they waived some fee they were going to charge. Was it because the order placer used advanced negotiation techniques? No! It was because they “just asked”. I started tracking this as an indicator and it turned into a great cost savings deliverable for the department.

    By the way, I drive a pretty nice jet black convertible 911 Porsche that has a lot of upgrades. It’s my baby, and it’s also a head turner. The check engine light went on recently, and that is never a good with a Porsche. The bill was for $11,000 because the entire engine needed to come out to fix the problem. I got it down to $7,000. The reason? I just asked, but I did it in detail, on every single line item of labor and parts. I presumed that I had the right to do this, and I didn’t care that nobody else exercises this right. I also presumed I’d get the discount, and I did!

    Mind you, “just ask” is NOT a replacement for benchmarking, cost modeling, bidding, and negotiation strategy development. It IS a tool in your arsenal to improve TCO, usually in a matter of seconds. In the world of low hanging fruit, this is watermelon.

    Are you using “just ask” as a part of your purchasing arsenal? Does your PO placement personnel employ this strategy, even when everything has already been expertly negotiated by someone in purchasing? Don’t assume the well is dry. Sometimes you have to “just ask” to find out…

    Come back and tell me about your successes with this, I’d love to hear your stories.