Category: Supply Chain

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.

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Purchasing is the school of hard knocks. A really good purchasing professional is one who’s made a lot of mistakes, but was a little smarter after every one of them.

Sometimes those mistakes are big though, and can take you to “purchasing hell”. I define “purchasing hell” as when a supplier is doing *exactly* what the contract says, and you’re mad as hell about it. There’s really no worse situation, because the supplier can’t be faulted.

They’re doing exactly what you told them to do, and you’re not happy about it, but it’s your own fault! In all likelihood, if you’re not happy, neither is the customer. Misery loves company….. I guess. Nobody else that I know really uses the term “purchasing hell”, but who knows, maybe this is how expressions start. Somebody has to go first.

The worst this ever happened to me was early on in my career with a complex software development contract. I made the mistake of agreeing to pay by milestones, and the supplier wouldn’t get a red cent sooner. That sounds great, right?

Well, my milestones were defined as key dates and not by key deliverables. In other words, whether or not the supplier was performing, I owed them money because that magic date came around where they were due money. I was in purchasing hell. The only worse experience I’ve had was a 1940’s technology endoscopy in the Middle East, except nobody told the medical provider that it was 2005. Worst supplier selection decision ever on my part.

I was pleased to read recently something recently on this topic of payment for performance, which is what prompted this particular blog. Starting this last January, Medicare has created a system of bonuses and penalties for nearly 3,000 hospitals as it ties almost $1 billion in payments to the quality of care provided to patients.

This law was instituted as a part of the new government program called the Hospital Value-Based Purchasing Program. It is a pay for performance program… run by the government no less. What a concept!

The other interesting thing that came about from this is that some of the “big name” hospitals got penalties, and some of the “no name” hospitals got bonuses. The program evidently is valuing substance over perception.

One of the biggest shifts that any purchasing department has to make is paying for results instead of paying for resources. Resources (goods and services) take up space and time, and may or may not get you to where you want to be in purchasing. Results are measurable, and they solve problems and capture opportunities.

I taught myself a useful trick years ago. It was after I got in a debate with a supplier over whether the contractual performance results were actually achieved or not. Predictably, they said they were, and I said they weren’t. The fact that this discussion was even taking place really bothered me (not as much as the endoscopy from hell though).

I decided I needed to create a mechanism so I would never have that discussion again with any supplier. I added a clause in all of my performance clauses moving forward that said “the extent to which this performance deliverable has or has not been met shall be the exclusive determination and decision of the Buyer.” No other opinions about supplier performance would count but mine and the customer’s. That’s the way I wanted it.

How are your contracts written? Are you putting performance clauses in place? Do they say whose opinion matters when there is conflicting interpretation of whether or not that clause was met? Or are you simply buying goods and services….. and letting the supplier off the hook….

Back to the government Medicare pay for performance effort. It still might fail miserably. I’m not saying they did a great job setting it up, because I don’t know that. I do like however that there is this shift to performance based procurement and payment models in our government healthcare system. With any luck, the program will be generating real results right around the time I’m forced to retire for health reasons. Personally, I can’t wait.

 

I was in Houston this last week teaching procurement negotiation seminars.

There are two quotes I distinctly remember from past trips to Texas. One was “Welcome to Texas. If you don’t like the weather, wait a few minutes.”

The other one, in response to me asking about how the food is in Houston, was “Ain’t nobody hungry in Houston.” In my case, that was definitely true. I can still taste the blackened catfish.

As also promised, the weather was crazy, with 30 degree temperature swings in the matter of a few hours. In the same day, I wished I had both a trench coat and a pair of Bermuda shorts.

One of the seminar attendees had previously attended one of my TCO seminars in Galveston, Texas. I’ll call him RD. RD said that as a result of attending that Total Cost seminar, he decided to root-cause a situation of escalating prices with one of his custom fabrication suppliers.

RD’s supplier wanted to meet with him to renegotiate pricing to reflect increased costs. He decided to reluctantly hear what they had to say and find out more information.

RD was in for a big surprise. Unbeknownst to RD, the supplier had been charging him 30% over standard price for a period of six months now, and to add insult to injury, wanted to increase it to a 35% markup over agreed upon standard pricing. It was bad enough RD was 30% over expected price, but the increase to 35% was taking it to another level! RD wanted an explanation, and quickly.

He then saw all the purchase orders to the supplier, every last one of them, was a rush order shipment – requiring supplier quick turns and expedited delivery. Supplier quick turns mean inventory must always available, which costs money. This was customer specific inventory, which adds even more cost, as there could be no inventory sharing with other customers by the supplier.

Of course the other obvious cost driver here is the shipping. Going from ground to air shipment is non-trivial in our field. Surely the customer is at fault here RD thought. That would be my first instinct too. Too often times, the customer’s lack of planning becomes purchasing’s emergency. Pretty soon it becomes standard practice and they don’t plan at all, and that’s when the last minute shipping costs really rack up.

It turns out this wasn’t the case at all. The person who was placing the purchase orders for this division had just been hired 6 months prior. For some reason, she was taught that if a requisition comes in for these fabricated items with no delivery date, she should just put that the items were needed in five days. Five days lead-time for custom fabricated items!

She was marking every single fabrication purchase order this way, with no idea of the TCO implications. She was just doing what she was told. Who can blame her? I was pretty clueless too when I first started purchasing.

The mystery was solved. TCO was spiking by 30% because a poorly trained employee was rushing custom orders that nobody was in a rush to receive. The supplier was scrambling unnecessary to fulfill these orders, incurring all sorts of costs, and they were losing money in the process.

This problem was easy enough to solve, but not before untold amounts of money went down the drain. The worst part is that nobody was happy about it! The supplier was losing money on the expedited shipping adder, the customer received items sooner than they needed them, and RD’s hard earned cost savings on the deal vanished into thin air.

The sad thing is, this kind of scenario is not so uncommon. Well intentioned customers make bad TCO decisions all the time. Most of the time we never find out about it until a lot of damage is done. In fact, urgent shipping as a replacement for good planning practices is one of the most costly business practices that customers often engage in.

Do you check to see what your customers are *actually* ordering against contracts you negotiate?

Do you follow up to make sure that your supplier and contract TCO strategies have really materialized in the hands of your customers?

It’s important for us to keep constant tabs on TCO well after the contract is negotiated. We really need to follow the entire lifecycle of the purchase and make sure that expenditures against that contract go as planned.

On the plus side, my stomach wants to move to Texas. Failing that option, I have to find someplace where I can buy good blackened catfish back home, and fast! I really have no choice in the matter. I don’t care where I buy it or what it costs. Call me a rogue customer, but this is a definite rush order.

Are you a coffee drinker? I’m a big latte drinker.

Years ago, I did a Make-vs.-Buy analysis, comparing the horrific amount I was spending at coffee shops on lattes to what it would cost me to buy a big foofy latte machine and make them myself.

My wife approved, and that was more important than what my cost model indicated (at least that’s what she told me).

Thankfully, both said the same thing – buy the latte machine, stupid! The one I bought is made in Italy, which makes me feel very European.

As if that matters.

Sometime back, I was at an airport getting ready for a flight. Since I couldn’t take my latte machine with me, I had to succumb to screwing up my cost model and buying a latte.

I went to one of the famous coffee houses, the same chain whose stock price I single-handedly kept up for so many years. I ordered their smallest size drink, which has only one shot.

Being nosey, I peered over the counter and watched them make it. For some reason, they were ok with that.

My heart sank as I watched them pour 2 shots, with one going in my drink and the other one going….wait for it…wait for it…. down the drain!

I asked her why she did that. She said their machine only pours shots in even numbers. I said “but you only have 3 drinks sizes, and 2 of them have an odd number of shots!”

She had a very deep and articulate response: “yep!”

Still quite shocked, I said “so you guys throw shots away because you can’t make an odd number of shots?”

Another “deeply analytical” reply came from the respondent: “all day long!”

She was cool as a cucumber about this whole thing, meanwhile, I was having heart palpitations and was more than willing to miss my international flight to get to the bottom of this. My client would understand, I rationalized.

“How about your other chain stores?” Her response – “that’s what we all do.”

I was devastated. I have to say, this was one of the low points in my life. The other one was a medical procedure that everyone *promised* me I wouldn’t need until I was 50. We’re not going to talk about that. I’m trying to suppress that memory.

Now just imagine how much energy this company spends on trying to reduce their costs with suppliers. Coffee, fixtures, latte machines, milk, cream, utilities, etc. I’m going to guess that their highest cost component is the coffee beans.

Coffee plants produce very little crop, the processing costs are very high and labor and machine intensive, and shipping and importation costs are high too.

In my case, the only type of coffee I buy is grown in South America and then later roasted in Italy, and then sent to the US! How much of the price I pay is going to shipping and import/export costs instead of to the physical product itself?

Of course I justify it, because using Italian roasted beans make me feel very European.

The purchasing professional that managed supplier selection for the latte machines may well have focused on acquisition cost instead of total cost.

What is the cost of throwing away shots all day long? In all your stores?

How much more would it have cost to buy latte machines that can make both an odd and even number of shots, and how much would be saved?

While purchasing people shed blood, sweat, and tears trying to shave off a little more from supplier profit margin, there are huge supply chain savings opportunities just going down the drain all the time, sometimes quite literally.

If I was CPO of this company, the first thing I would do is analyze all costs such as this.

One of their employees once also told me that they also throw away all opened coffee bags at the end of every day (we’re talking unused coffee beans here), as well as all opened bottles of syrup, even if they are still full.

I can’t say that’s true for sure, but if it is, all I can say is “wow”. I could also say “give them to me!!!” but even I’m not that nosey. My wife might be though. I’ll talk to her after this article.

Are you focused on acquisition price or are you focused on total cost?

Have you ever gotten a great acquisition price, but gotten a terrible total cost deal?

Do you know what costs are unnecessary or being completely wasted with your suppliers? Have you checked?

Successful companies can get complacent with how they do business. The same thing happens with purchasing professionals.

It’s easy to assume you are successful because of everything you do, when in fact it’s very possible, and often times the case, that you are successful in *spite* of many of the things you are doing!

Don’t assume you are the exception. I see very smart purchasing professionals miss opportunities all the time.