War Story #1

Here is #1 in my exciting series of 'War Stories'. This video is on The Business Need and tells how a quiet and introspective engineer had the key to change procurement strategy

Time to ditch CPI as a price variation mechanism?

Time to ditch CPI for B2B price variation formulae?

The Consumer Price Index (CPI) is widely used for contract price variation in business to business contracts. Paul Rogers argues that CPI is no longer fit for purpose as a proxy measure of business input costs.

One of my procurement mentors was a retired army Major. I think it’s fair to say he ‘marched to the beat of a different drum’. It was the 1990s, and he told me that he still had a black-and-white television at home. “Why’s that Philip?” I asked him. “Black and white televisions are at the mature phase of their product life cycle. Reliable, defect free, and…” he leant towards me as if sharing a state secret and whispered “…considerably cheaper than colour televisions!”

I think there is a phrase in French for things that you wish you had said at the time, but only thought up later. (L’esprit d’escalier’; the ‘spirit of the stairs’) I wish I had pointed out to Philip that life is polychromatic and he was only cheating himself by clinging to something that belonged in a museum. Alas, Philip has long since passed to the great Officer’s Mess in the sky. But the attraction to the familiar long after it has ceased to be relevant is not confined to the cathode-ray tube.

Generals always fight the last war
The Consumer Price Index is widely used in contract price adjustment formulae to adjust contract prices. The attraction is that it is easily accessible, can be tracked by both parties, and is now updated monthly. This means that there is less ‘lag’ between the end of a period and the publication of the CPI index.

But what happened in March 2022? (OK, apart from Russia invading Ukraine.) In Phase 2 any linkage between CPI and PPI was broken. Whether it was post-COVID supply chain disruption, or international geopolitical events doesn’t really matter, does it? In Phase 2 contracts varied on the basis of CPI alone rewarded suppliers with a bonus. Look at the result for the first half of 2023. If we believe that PPI tracks actual ’factory gate’ pricing, then if contract pricing was varied 100% by CPI, suppliers got an unearned bonus from their clients of 2%. Clients 0 Suppliers 1.

Changing of the Guard in 2024
Phase 3 is different again. 12 months of relentless political focus on CPI paid dividends as the CPI fell by half. But hang on! What’s happening to PPI? PPI is higher than CPI in Phase 3. Clients 1 Suppliers 1? I don’t think the ‘swings and roundabouts’ argument is very strong.

The observable evidence is that using CPI alone as a price variation mechanism results in contract price changes that may be unrelated to the actual cost experience of our suppliers.

The clue is in the name
CPI reflects average price changes across a broad range of consumer goods and services. This means that it may not accurately capture the specific cost pressures faced by businesses in different industries. For example, contract prices for construction projects may be heavily influenced by fluctuations in the prices of raw materials like steel and concrete, which may not be fully reflected in the CPI. As a result, using the CPI to adjust contract prices may not adequately account for the unique cost structures and inflationary pressures faced by businesses in various sectors. Here is the contents of the basket of goods and services that is used to calculate CPI;

• Food and non-alcoholic beverages
• Alcohol and tobacco
• Clothing and footwear
• Housing
• Furnishings, household equipment, and services
• Health
• Transport
• Communication
• Recreation and culture
• Education
• Insurance and financial service

An obvious question to ask procurement practitioners is this; what has this got to do with the input costs of your suppliers?

The shopping basked is specifically designed to represent the typical purchases of metropolitan households over a year. I have heard the argument that it does represent the experience of our supplier’s staff in their day-to-day purchasing. But what has that got to do with our supplier’s costs?

CPI is designed to measure changes in consumer prices at the retail level, not price variations experienced by businesses at the wholesale or producer level. Businesses may face cost pressures from changes in input costs, supply chain disruptions, or shifts in global market conditions. This can -and has- lead to mismatches between suppliers actual cost increases and contract price adjustments. This will affect the profitability and viability of contracts leading to winners and losers.
Porter’s Sixth Force
I understand that if Michael Porter had the chance to update his ’Five Forces’ model, he would add in government regulation. In their note to the September quarters’ CPI result, the Australian Bureau of Statistics (ABS) mention that “Electricity prices fell 17.3 per cent in the September quarter and 15.8 per cent in the past 12 months.” A great result, welcomed by all consumers. The ABS then lists a variety of government interventions that have reduced the cost of electricity, before mentioning, almost as a footnote, “Excluding the rebates, electricity prices would have risen by 0.7 per cent in the September 2024 quarter.”

My point is that CPI has become such a topic of public debate, especially now that it is published monthly, that governments influence the CPI to serve their political interests.

This diminishes the utility of CPI as proxy measure for actual business costs.

The ‘best of the best’?
Are your suppliers ‘average’? Do you go through complex and sophisticated procurement processes to select suppliers who perform in an average way? No, you don’t. So why use a proxy measure for inflation which assumes that suppliers experience cost inflation the same as the average consumer in the supermarket? It is time to ditch CPI as a proxy measure of business to business inflation.

Here are two alternatives:
• Construct a cost model with your suppliers which identifies cost drivers influencing at least 80% of the final price. This is likely to include wages, materials and overheads. Agree with your suppliers the Wage Price Index (WPI) that is most relevant for wages, and the PPI that is most relevant for materials. Perhaps agree a composite index based on WPI and PPI for overheads;
• Construct a cost model with your suppliers which identifies cost drivers influencing at least 80% of the final price. Get them to track and validate actual cost changes in respect of wages, materials and overheads.

Remember that digitalisation is driving significant productivity improvements in every organisation on the planet including your suppliers. We should build the expectation amongst our suppliers that they will moderate any unavoidable cost increases through offsetting productivity improvements, which they should demonstrate in black and white.

Or colour, as the case may be.


Procurement exceptionalism

Procurement exceptionalism; how to lose friends and alienate stakeholders

Procurement exceptionalism is the belief that belief that people who work in procurement are exceptional in some way. Procurement practitioners are claimed to have characteristics or capabilities which are unusual or extraordinary which makes them different from other stakeholders. The term carries the implication that procurement people are superior in some way, usually in terms of commercial processes. The archetypal procurement villain José Ignacio López de Arriortúa famously required his team to wear their watches on the right wrist in order to emphasise that they were special and ‘different’ from their GM colleagues.

"Procurement; the master key to unlocking business potential"
I searched on LinkedIn for posts containing the word 'procurement' and came up with this statement. While we can forgive an influencer for a degree of puffery, I wonder how stakeholders in other functions might react to the news that their organisation's business potential can be optimised by adding the magic ingredient "procurement"? We may be able to ask them when they eventually stop laughing.

I have profiled the capability of procurement practitioners in organisations large and small, public and private, from Melbourne to Manchester and from Miami to Manila. I can say that there are some talented people in procurement and many people -including me- who have development needs. Procurement people are not -on average more capable than other knowledge workers.

Department, process or function?
Let's examine another phrase, also sourced from LinkedIn;

"In this article I reflect on the critical role procurement plays in driving business growth, managing supplier relationships, and shaping strategic decisions."

Let's give the author credit for the use of powerful verbs like 'driving', 'managing' and 'shaping'. Bonus points for getting both 'critical' and 'strategic' into the same sentence. But what does the sentence mean? In particular, what is meant by the word 'procurement'? The author does not feel the need to expand on what is meant, but in this context, it could mean one of three things. Let's examine them one at a time. 

The first is procurement as a department. I suspect that this meaning is what the author intended, but let's state the obvious.  An organisation can have class-leading procurement processes and class-leading procurement outcomes without having a procurement department. In everyday use if somebody uses the word 'procurement' we can assume that what they actually mean is the procurement department. 

So is it reasonable to infer that the procurement department is "critical" to business growth? This will be news to most business development executives. I have worked with companies where new product development is a critical business process, and design, procurement, manufacturing and suppliers are united in achieving target costs. I have never worked with an organisation that would claim that the procurement department is the only enabler of business growth and I have worked with some stakeholders who would see no role for the procurement department in business growth. And don't get me started on 'shaping strategic decisions'!

The procurement process is a foreign land
The second option is that the author used the word 'procurement' to mean the procurement process. At the risk of being repetitive, can I point out that the procurement process is present in all organisations whether or not they have a procurement department.  The organisation may procure well or badly. Stuff gets bought and delivered. Negotiations take place. Relationships are managed, with or without a procurement department.

The end-to-end procurement process involves stakeholders working in different functions, fulfilling different roles.  This means that that the use of the word 'procurement' to mean the procurement process does not rely upon the assumption that people who work in the procurement department are more capable than other stakeholders. It is more inclusive and less conceited.

It is common to encounter stakeholders of the procurement process for whom the procurement process is a foreign land. They need guidebooks, translators and navigational aids to find their way from where they are to where they want to get to. For these stakeholders, the idea that the procurement process drives business growth or shapes strategic decisions would be greeted with derision.

The procurement department ≠ procurement
The third option is that the author used the word 'procurement' to mean the procurement function. This is a more abstract concept and the procurement function includes procurement governance, procurement organisation, the capability of full and part-time procurement practitioners, the quality of procurement processes and systems as well as other enabling resources that contribute to an organisation fulfilling its needs for external resources.

By decoupling the scope of the word 'procurement' from the procurement department or the procurement process, the phrase ‘procurement function’ allows us to adopt a more holistic approach to describing an organisation's capability. The benefit of doing this is that it does not involve the conceit of assuming that when you join the procurement department you magically acquire capabilities not possessed by other stakeholders in the business.

A second benefit is that it helps manage the expectations of stakeholders who naturally want improved outcomes from "procurement". How many of us have seen business cases for investments in procurement technology which assume that the cash releasing benefits of improved procurement outcomes will begin flowing after implementation? But then a constraint emerges; it might be limited procurement capability or clumsy procurement governance. Use of the phrase 'procurement function' highlights that there are other elements of the function that need to be addressed and that technology and systems are only one part of the procurement function.


What about 'shaping strategic decisions'?
For the avoidance of doubt, I believe that the procurement function can be a source of competitive advantage and I also believe that it is an important contributor to strategic behaviour. But we cannot allow exceptionalism to blind us to the fact that 'procurement' (i.e. the procurement function) is not the sole source of competitive advantage or strategic capability in an organisation.

We can be enthusiastic supporters and advocates for professional procurement without claiming that we have some esoteric knowledge or implying that our stakeholders are commercially naive and need us to rescue them from the abyss of their nothingness. If you were constituting a team to address a strategic challenge, would you involve people who thought that their peers are less competent than they are and believe that they deserve to be involved because of a word in their position description?

Thinking about thinking

Thinking about thinking
When we think of tools that support knowledge workers, we might consider the World Wide Web, the Microsoft Office suite of programs and even artificial intelligence. Paul Rogers explores their impact on the decision-making capabilities needed to make sense of the explosion in data and information.

I am so old I can remember a time before Skynet, when we had to write to our suppliers to find out how many widgets we had bought. We had invested millions in IT systems but couldn’t say how many blue biros had been purchased. Fast forward to today, and (many) organisations are awash with data and visualisation tools to analyse their spend by supplier, by category and by location. And they don’t buy blue biros anymore.

It can be difficult to judge the significance of these changes because they are happening right now and we do not have the perspective of time to reflect upon them. One suite of thinking tools that I have found helpful was created by Terry Borton in 1970. Borton suggested reflecting on the following three questions;
• What?
• So what?
• Now what?

Assault on batteries
I have created a data set on spend on batteries to try and bring to life the three questions. The data is fictitious, but the principles apply to many indirect categories.

The total spend on batteries is $250,000 a year. Of that spend, 90% is accounted for by AA and AAA batteries. I have used Microsoft Excel to sort the batteries by type (AA or AAA) and then by unit price. I have applied conditional formatting to colour code the unit price from low to high and also used data bars to highlight where the spend is concentrated. Not exactly cutting edge stuff, but hey! I started out with SuperCalc.

The ‘what?’ question
Whether you use VisiCalc (look it up) or a visualisation tool like Power BI or Tableau the What? question asks us:
• What does the data reveal?
• What is happening?
• What are the patterns or trends?

In the data above, the answers are:
• 90% of the spend is concentrated on two battery types, AA and AAA;
• There are at least four brands of each type of battery purchased
• There are multiple variants of each battery type, even within an individual brand
• The unit price of AA batteries varies from $0.60 each to $4.98 each
• The unit price of AAA batteries varies from $0.50 each to $4.75 each
• The lowest unit price battery accounts for less than one percent of all purchases
• There appears to be a strong preference for one brand, Energizer

In the past I may have written that the capabilities needed to answer the ’what?’ question included data analysis. But that is only true to the extent that I know what attributes of the data are important. I know that the unit of sale matters because every supplier uses a different pack size. In order to analyse the data we need to use unit price in order to compare like with like. That’s not going to earn me a Nobel Prize, is it? Could it be that the ability to devise and manipulate a pivot table in Excel is no longer as important as it once was?

The ‘so what?’ question
My contention is that the second and third questions in Borton’s framework are now more important for knowledge workers than they were historically.

What?
So what?

90% of the spend is concentrated on two battery types, AA and AAA
In order to maximise the return on investment of our time it makes sense to focus on these two types.
There are at least four brands of each type of battery purchased
Purchasing of batteries is relatively uncontrolled with users exercising personal discretion over which brand is bought
There are multiple variants of each battery type, even within an individual brand
Users need to know what is the most appropriate quality level (Everyday, Max, Max Plus, Ultimate) for their application
The unit price of AA batteries varies from $0.60 each to $4.98 each
In order to optimise value in purchasing AA batteries we need to match the battery type to the application
The unit price of AAA batteries varies from $0.50 each to $4.75 each
In order to optimise value in purchasing AAA batteries we need to match the battery type to the application
The lowest unit price battery accounts for less than one percent of all purchases
Users prefer to purchase more expensive batteries (Max and Max Plus) rather than the battery with the lowest unit price
There appears to be a strong preference for one brand, Energizer
We need to understand what the source of the user preference is, and how easy (or difficult) it may be to change users’ preferences.

The capabilities that I have (tried to) demonstrate in the table above are higher level cognitive abilities than sorting, counting or totalling data. I have applied knowledge and experience (and perhaps even some wisdom) to the data to interpret what is significant.

The ‘now what?’ question
‘Some men see things as they are and say why? I dream things that never were and say, why not?’ – George Bernard Shaw

If we are experiencing transformational change because of rapid advances in technology such as artificial intelligence it is inevitable that some of the frameworks which have served us in the past will become less relevant. In the example of the batteries, there are a number of options of what could be done next;

• Hard substitute generic equivalents for branded batteries in the purchasing system;
• Reduce the number of brands of battery bought from four to one;
• Disempower individual users from purchasing batteries and enforce policy by centralising responsibility for purchasing batteries;
• Address the number of different battery variants in use (Everyday, Max, Max Plus, Ultimate) by selecting a mid-quality solution e.g. ‘Max’;
• Address the number of different battery variants in use (Everyday, Max, Max Plus, Ultimate) by issuing guidance on which devices require something other than an alkaline battery (e.g. which are the high drain devices that may actually need a premium battery);
• Collect ‘spent’ batteries in battery recycling drop off boxes to avoid them going to landfill (or starting fires);
• Adopt rechargeable batteries to reduce waste and be more sustainable.

The choice of which options are right for your organisation requires higher level cognitive skills of evaluation, judgement and selectivity. In particular, while options four and five in the list above have the most potential to release value, they may also be the hardest to manage from a practical point of view. How do you change the behaviour of hundreds of individual decision-makers? It’s going to need more than sending them an email or drafting a carefully worded policy statement!

Positive thinking
I find Borton’s three questions to be deceptively simple. Answering the second and third questions requires different and higher level cognitive capabilities than answering the first question. There is no function in Excel that reads =RELEASEVALUE(A1:K33,567,2,FALSE)

The Seventh Wave


The Seventh Wave

“Life can only be understood backwards, but it must be lived forwards.” Paul Rogers looks back at the waves of disruption affecting procurement, waxes his surfboard and prepares to ride the seventh wave.

Death of a salesman 1950 - 1988
We can characterise the business-to-business sales process during this period in terms of a proactive salesperson targeting the budget holder or Very Important Top Officer (VITO) and pitching their value proposition directly to the decision maker. If there was a purchasing person involved, they would raise the Purchase Order long after the deal had been done. Of course, there would be some exceptions to this generalisation, but I will characterise this period as a time of “selling to”.

The First Wave 1988 - 2015
The post-war dominance of relationship-based business-to-business sales processes was disrupted in the 1980s with the emergence of professional sales strategies. Two methodologies warrant attention; SPIN Selling and The Challenger Sale. SPIN Selling involves a proactive salesperson and a reactive prospect. Of course! But at least it recognised that the prospect has needs, though the salesperson is needed to ‘help’ the prospect to define their needs. What does that say about the role of procurement people?
The Challenger model is best understood by reference to the subtitle of the 2011 book that launched the approach. It reads “Taking control of the customer conversation”. Not much room for an empowered procurement team there! The Challenger model also assumes a proactive salesperson interacts with a largely passive prospect. A key difference between SPIN Selling and the Challenger Sales model is that in the Challenger model the salesperson acknowledges that the prospect may already have developed an understanding of their needs and understand the market. Remember the matrix based approaches so beloved by procurement folk were first published in the 1980s and this is just 30 short years later. We can characterize the first wave in terms of increasing professionalisation of sales practitioners beyond the ‘relationship sell’, but it is a still a drama with no role for procurement practitioners.

The Second Wave 2000 - 2015
The second wave of disruption affecting business-to-business sales processes didn't happen in the sales function at all. It happened in procurement departments in larger corporate and public sector organisations. Investments in procurement capacity and capability and the implementation of procure-to-pay systems which hardwired procurement governance created the preconditions for ‘buying from’ instead of ‘selling to’. Sales strategies focused on VITO and budget holders were identified as ‘maverick behaviour’, and procurement teams increasingly took control of their organisation’s procurement process.
Of course, some VITOs still did their own thing, but the timing of procurement decision-making, the selection of which stakeholders were involved, the definition of needs, the specification and the selection of bidders all became decisions for the client, not the sales organisation.
The emergence of professional procurement disrupted the business-to-business sales process into the business-to-business procurement process.

The Third Wave 2015 - 2022
The Third Wave began in the early 2000s when the originator of SPIN Selling (Neil Rackham) authored a book called Rethinking the Sales Force with John DeVincentis. While there are still some sales teams who deny that their roles are changing, the emergence of ‘buying from’ instead of ‘selling to’ meant that progressive sales teams had to refocus their effort using the segmentation methods so beloved of procurement practitioners. If it is premature to ascribe the First Wave to the emergence of professional procurement, the Third Wave is 100% the consequence of professionalisation of procurement.
Proposal management has been around for a long time, but as RFPs became increasingly important as a way of winning work, more and more sales teams recognised the need to develop capacity and capability in proposal management. The point is that the business-to-business procurement process has changed how organisations organise and resource their sales processes.

The Fourth Wave 2022 - date
The Fourth Wave is happening right now. It involves the adoption of Artificial Intelligence (AI) by proposal teams and it is changing both sales and procurement processes. To understand why, let's classify the content in an RFP response into three types. Type one content is content that does not change from bid to bid. This might include quality frameworks, risk management frameworks and other governance that is not updated for each proposal. Type two content is content that may be configured for different proposals but is substantially the same from bid to bid. Case studies would be the most obvious example. Finally, type three content is content that is originated specifically in response to an RFP question. This might involve designing a bespoke solution for a particular client's problem.
This is both a challenge and an opportunity for proposal teams. The opportunity is to use AI to accelerate the creation of draft proposals using a library of draft content. Type one and type two content can be configured quickly, focusing the proposal team's effort on originating type three content. The challenge is that machine learning models need training data. Lots and lots of sample proposal responses. Where does the training data come from? There are two potential sources of training data. The first is previous proposals developed by the organisation and the second is public domain information that can be scavenged from competitor’s websites.
This might include quality policies, risk management frameworks, etc. Critically, what it won't include the is type two and type three content from competitors. But it will be relatively easy to train on type one content. The way the training will work is that the model will be taught that content A is poor and will score 3/10 or 4/10 in evaluation. Content B is average and will score 5/10 or 6/10 and so on. AI solutions will produce content designed to score 10 /10 and will incrementally improve the content to approach that goal.

The Fifth Wave 2024 onwards
Imagine that multiple bidders all train their large language models using similar content. What do you think will happen next?
The AI-generated content will progressively converge until submissions from different bidders are virtually indistinguishable.
In the past type one content might have been scored in a range from 5/10 to 8/10 during RFP evaluation. It is likely that the range will compress so that there might be a range from 8/10 to 9/10. For type two content there may also be some convergence, as the AI algorithms progressively align content to the evaluation criteria of the prospect. This means that clients who share their evaluation criteria will get back responses with exactly what they are looking for. Result!
The consequence will be that some content of written RFP responses will no longer be a discriminator between respondents

There may be a gap between respondents who use AI as part of their proposal generation and respondents who do not. For those respondents who do use AI as part of their proposal management solution, content generated by large language models will increasingly converge, and the difference in quality between responses will be within the margin of error for the scoring and evaluation process.

The Sixth Wave 2026 onwards
My contention is that AI-created proposals will reduce the effectiveness of scoring of written submissions in support of proposals because of two key processes. The first is the ability of large language models to generate content which gives the client exactly what they are looking for. Well written easy-to-navigate proposals which ‘tick all the boxes’.
What the evaluation team is scoring is the quality of proposal writing, not necessarily the underpinning capability of the organisation submitting the bid.
The second process is the progressive convergence of AI-generated content, undermining the ability of documentary evaluation to distinguish between respondents. What is the point of spending hours, days or weeks evaluating written submissions if the respondents all score between 75% and 80%? Is that “clear blue water?” Is it unrealistic to anticipate that other forms of evaluation will become disproportionately important? Interviews, presentations, reviews of past performance, site visits and maybe even client testimonials. The RFP evaluation process will be disrupted just as surely as professional procurement disrupted the sales process in the Second Wave.

The Seventh Wave 2028 onwards
I suspect that AI-driven RFP evaluation solutions will emerge, if they haven’t already. There may be little point in scoring type one content as the differences between competing submissions may be minimal. Such content may be evaluated on a risk-rated basis, or simply pass/fail. Many procurement teams rely on third-party compliance providers such as Avetta. An ‘adjacency’ for compliance providers is not only to host documents, but to evaluate the submissions against a common framework using a panel of subject matter experts. Imagine the savings if every client inviting proposals from (say) facilities management providers agreed to accept the scoring of each company’s governance library by an expert panel instead of reading and scoring multiple sustainability frameworks, environmental frameworks, gender equality frameworks, quality systems, risk management frameworks etc
The time saved could be better deployed in interviewing the proposed delivery team, exploring the feasibility of the proposed solution, validating that the claims made by the proposal writers are supported by evidence in the field and, of course, negotiating mutually acceptable terms.

No hoverboards here!
“Prediction is very difficult, especially if it's about the future!” I tried to envisage the near future for business-to-business procurement processes without resorting to stale old cliches such as showing procurement practitioners on hoverboards. Instead, I went for procurement practitioners on surfboards, riding interacting waves of disruption. But what do you think? Let me know in the comments!