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The Incredible Payback

AMACOM Books

Chapter One

Traditional strategic and tactical approaches to sourcing, building, and distributing successful products will not allow purchasers to see or capture big paybacks because traditional approaches only provide partial solutions - they don't include Best Practices and Spend Management. Most traditional purchasing and manufacturing functions take a narrow focus that does not reach all key areas of the supply chain; they are not big enough and deep enough to lead the kind of change we envision. Furthermore, since most traditional purchasing organizations' systems are not well-integrated and cannot meet all key information requirements, achieving big paybacks with Spend Management is a challenge. Although it is possible to achieve, year after year, good savings with only limited or partial information, to sustain the 3 to 5 percent total spend savings that we advocate, companies must see the entire spend and they must see beyond this year's budget. Achieving billions of dollars of savings without hurting the supply base or cheating customers out of value is the challenge of every producer, and Best Practices and Spend Management are the answer.

Supply chain risk and uncertainty have arisen as global outsourcing has increased. When companies move more and more of their manufacturing business outside to contract manufacturers, they create more logistics work as materials move through complex supply chains. Many of the hands that touch the materials are not well connected to the end producer, and this also generates more risk that traditional operations are not equipped to handle. As supply networks have become more complex, the risks and the opportunities have arisen as well.

Purchasing processes that limit payback potential include organization structures that conflict or overlap, missing data, and bad practices. Bad practices create waste, which is easy to spot, but capturing and using the right spend data is not as easy to do, and it requires more focused attention. Enterprises that do not maintain a strong focus on Spend Management, which is supported by Best Practices, allow potential paybacks to slip away, and they usually do not know it! Furthermore, the sheer difficulty of data gathering and performance monitoring in traditional operations often obscures the larger vision and goals because managers find themselves sub-optimized by smaller, tactical objectives.

How to Evaluate Your Supply Management Group's Maturity and Competence

There are ten clear pitfalls that limit a supply chain's contribution to profits and growth. These problem areas also mark the difference between mature organizations that are working on all the right issues and bringing along the best resources, and those operations that are stuck in a tactical day-to-day grind.

Before jumping into fixing each of these ten problem areas, however, we recommend that managers perform a quick survey of their operation's capabilities and become familiar with key work areas: understand where procurement people are really spending their time and where there may be gaps. Gene Richter, the former chief procurement officer of IBM, used a thirteen-question checklist to evaluate purchasing performance and to understand what areas are important to the group. This checklist helps to highlight questionable and problem areas and serves as a great starting point for further gap analysis and spend focus. The checklist raises more questions when supply management is reviewed, and it should highlight strengths as well as obvious weaknesses. Use it as a starting point to examine exactly what your company does in the supply chain: where the emphasis is, and where the big dollars are. If your primary area of responsibility is engineering or manufacturing, this checklist will be a perfect jumping-off place for reviewing supply chain operations. These questions are also useful for customer/supplier or engineering/procurement teams to use if they want to streamline their processes, and also to identify and focus on a few important tasks (see Figure 2-1).

Building on Your Strengths

No purchasing group covers all areas equally well. Harley-Davidson, for instance, works very hard on strategic planning and supplier relationships. Although Honda's purchasing was not strong on computer systems integration, purchasing people worked well with manual data that was accurate and available. We are sure that every group that performs a good management review will find one or two of the most common mistakes made in every supply chain organization. There is not one company that can demonstrate excellent performance in all areas, and very few companies rank above average all around. However, if your group has a few strengths - and some weaknesses - that are important in your industry, we urge you to build on these strengths and see what happens. The ten common mistakes shown in Figure 2-2 are problem areas that we see blocking the progress of far too many good organizations. We think that some, if not all ten, of them can be addressed immediately in ways that will actually change current performance. Before the cure, however, comes diagnosis and treatment.

Low Expectations

Coauthor Nelson calls this mistake "operating at kindergarten level in a grad school environment," but the practice of allowing purchasing to be an underachiever is an expensive approach to global supply management because it underpowers a vital contributor to corporate profits and growth. Unfortunately, examples of low expectations (and low results) in procurement are common. When compensation and board of director's representation, for instance, does not include supply chain management at high levels, performance suffers. Decisions tend to overlook procurement's contributions to profit, and budgets for staffing and resources in supply management are limited. Or when procurement planners' and managers' compensation is lower than that of managers in other areas, the message is clear: Procurement is an administrative process that makes the wheels turn and keeps the paperwork flowing, but it somehow isn't as professional or important as finance or marketing.

Low expectations make the challenge even more difficult because no matter how good an organization is, no matter how eager its employees are to do their best and to make solid contributions, if the expectations for purchasing's role in the business are low, chances are the results will be the same. High expectations produce high results in sports as well as business; the best athletes in sports such as tennis and golf live with their own internal high expectations, as well as the daily responsibility to stay tops in their rankings, and they know the effect a bad crowd has on the game. When Jimmy Connors and John McEnroe played home matches at the U.S. Open in New York, for example, they both raised their level of game to unexpected heights because the home crowd expected them to play better than ever - and no one was disappointed. But when the U.S. Davis Cup team played hometown favorites like Goran Ivanesevic in Zagreb, Croatia, they suffered painful losses as the crowd cheered their missed hits and booed winners. It made the hill that much steeper and higher to climb. In tennis and golf, mental attitude counts for more than 90 percent of the game; and in new and innovative areas like supply management, attitude and respect count just as much.

Second-Tier Does Not Mean Second-Class

Low expectations can be especially damaging out in the supply base. Many suppliers work hard to deliver perfect quality and on-time performance, but because of their size or clout, they often do not get the respect and appreciation they deserve. It is ironic that as outsourcing places higher and higher proportions of product value in the hands of small- and medium-size suppliers, many first-tier operations still undervalue second- and third-tier contributions.

Second-tier suppliers are often the source of innovation and growth. For first-tier producers, however, 80 percent of the United States' annual new products are developed and produced by second-tier companies. Although these suppliers may not represent the largest portion of a corporate spend, their unique contributions make the supply chain more globally competitive, and that value is beyond measure.

Internally, procurement groups can also suffer from lowered expectations or unclear objectives. We will talk later about what metrics work best to measure supply chain performance. There is great power in numbers; and continued high-level purchasing performance and good press throughout the supply base are the fuel for raising low expectations.

Decentralized Purchasing

Decentralized procurement organizational structures were originally designed to guarantee continuous delivery of plant-specific products directly into factories in order to keep the lines running at all costs. However, they are now our biggest barrier to improved Spend Management, which is a tremendous problem in supply management today. A decentralized purchasing structure is one in which purchasing offices and decision making are not coordinated, supplier strategies are not linked, volume is not leveraged, and relationships exist at low organizational levels and there are local incentive schemes. Although purchasing offices are maintained at the plants or at divisions, there may be a central procurement function as well that performs a few limited procurement functions. Commodity and cost analysis, quality and material specifications, negotiations, buying, strategic planning, and expediting may be conducted at any and all levels and at many different locations in a decentralized organization - and that is the problem. This approach to managing material flows is a legacy of the vertical integration model. Although some elements of that model have shifted as outsourcing and other supply chain flows have moved out, the basic decentralized foundation imprint remains in place in so many corporations that we know it still needs to be addressed at very high levels. Decentralized operations have a tendency also to put one plant in competition with another for the same supplier's work.

Maverick Buying

What happens to the spend, for instance, in a billion-dollar corporation, when every plant maintains its own team of buyers that orders maintenance and repair operations (MRO) materials independently? Because MRO parts and supplies are unglamorous, they are usually overlooked when companies first attempt cost reductions. However, MRO is one of the easiest opportunity areas starting out. As John Deere discovered when a planner studied the company's MRO spend, the result was $1.4 million for 424 different varieties of gloves, all intended to be used on the production floor for basically the same purpose, before being discarded. When the glove supplier mentioned to one Deere analyst that Deere was paying $7.50 for a single-use pair of gloves, while the competition paid $1.50, and then cleaned and reused the gloves, the facts hit home - decentralized spend decisions not only encouraged maverick buying but also increased the cost! By switching to a more-sensible buying strategy that included a single supplier, fewer varieties of gloves, and better prices, planners realized immediate savings of 35 percent, or $490,000, almost half a million dollars in gloves alone! Even Deere suppliers knew that lack of control bred inefficiencies! If that type of variance existed for one simple production item, how much craziness would Deere find with bigger items like tires and engine components?

The issue of cost effectiveness is key in any decentralized operation, but there are other problems as well. For suppliers that may be shipping materials to customers at more than one plant, at different prices or specifications, the customer is not showing what Honda calls "same face," which is a uniform approach to buying and communications that minimizes confusion and saves time. Quality specifications may differ from one plant to another, even from one engineer to another, and when the purchasing system allows product or design proliferation, or when there is not an integrated central database to tell the story, no one is the wiser. In a growth company launching many new products each year, this is a problem;, but in a mature industry that earns predictable revenues on a known set of products, it is inexcusably expensive.

Curious Incentives to Stay Decentralized

The centralization/decentralization decision, however, is more than a simple choice based on good analysis of the spend, cost benefits, and production demands. There is strong emotion surrounding the question of whether to decentralize - how much or how fast - and where there is emotion, there is usually power or money. These two issues must be addressed when companies consider how to best structure the supply management area: cost allocation for a central procurement department and the division or plant manager's incentive to retain purchasing power.

First, it costs money to maintain a central purchasing operation, especially when it is staffed by planners who are paid more at central planning than if they were working at the plant level. Central procurement operations require good data from an integrated purchasing system, and this system will probably cost more than smaller plant-level operations. The funding to operate a central system comes from allocations placed on the plants or the division. In essence, the plants pay for planning, negotiating, and buying by a central group that leverages the combined size of all the smaller plants and divisions, while making buys that ideally should work to the advantage of all parties involved. Therefore, there may be a trade-off between the central group's ability to leverage the buy and the plant's contribution to the cost of the central group.

Fair Is Fair

When a certain market or group experiences sudden market downturns and no longer needs or can afford its allocation to the central group, there must be an agreement already in place that reduces the purchasing expense, not necessarily staff (sometimes staff can be reallocated to other businesses or product lines that are growing) at headquarters or at the plant level. If the central operation doesn't agree to "share the pain" - sometimes the central staff has the resources to "save the day" that one plant alone couldn't muster - then why should plants choose to delegate this critical operation to them?

"But We're Special, We're Different"

A second issue that is raised as a quiet objection is often veiled in the "but we're different" argument.

Continues...

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Excerpted from The Incredible Payback by David Nelson Copyright © 2005 by David Nelson, Patricia E. Moody, and Jonathan R. Stegner. Excerpted by permission.
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