Procurement
War Story #1
January 01, 2025
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?
October 10, 2024
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.
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
September 09, 2024
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?
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?
Big Shopping
June 06, 2024
Big Shopping
What is "strategic" about strategic procurement? Paul Rogers started work when the default name for the function was 'purchasing'. Here Paul tries to distinguish whether anything procurement practitioners do qualifiers for the adjective 'strategic'.
One of the fascinating things about the evolution of the procurement function is the emergence of the word 'strategic' as an obligatory adjective to describe everything that we do. Gone are the days when departments were merely procurement departments. Now they are proudly labelled as 'strategic procurement'. What was once a 'procurement plan' is transformed into a 'strategic procurement plan', in the same way that a tadpole metamorphoses into a butterfly.
The ubiquitous use of the word 'strategic' raises the question; 'what exactly is strategic about procurement?' As I am hip to the happening vibe, I did what all self-respecting practitioners would do and raised that prompt with ChatGPT. The response was:
"Strategic procurement involves more than just buying goods or services; it involves aligning procurement decisions with the organisation's overall goals and objectives."
So the paragraph in the RFP for office supplies that is headed "background" transforms what would otherwise be a routine operational market enquiry into a strategic act? An article in the Harvard Business Review by Roger L. Martin has argued that a plan is not a strategy. Martin argues that many practitioners mistake planning for strategy and suggests that they are completely different things. Martin's definition means that nothing that procurement practitioners do can possibly be strategic. His article directly challenges the conventional wisdom replicated by ChatGPT. Let's look at some practical examples to explore the issues.
Example #1
A ‘strategic’ procurement department prepares and issues a request for proposal for office supplies. On receipt of the responses, they shortlist the two lowest bidders for subsequent negotiation and select the provider who performed best against their evaluation framework. Is this strategic behaviour? I think the answer has to be 'no'. It is an operational activity following prescribed rules, processes and policies and is unlikely to have any significant impact on the organisation's performance.
Example #2
Many years ago, I was at a procurement conference and the Chief Procurement Officer of one of the world's largest corporations explained that senior managers at the organisation had no idea what the word 'sourcing' meant.
She told them that "it is the equivalent of shopping."
"Oh, they said, now we understand. So what is strategic sourcing?
"Big shopping!" she replied.
Cue audience laughter. I didn't laugh. At the time I thought she was completely wrong, but now I think she may have been correct. In what sense is consolidating variety, harmonising specifications, aggregating volumes and issuing a competitive enquiry, strategic behaviour? I get that there may be a some influencing and change management to get to that point, but isn't that what managers are paid to do? How is that strategic?
The World according to Roger Martin
Martin claims strategy is:
"...an integrative set of choices that positions you on a playing field of your choice in a way that you win."
Martin argues that you can prove in advance that a plan will work but that you can't prove in advance that a strategy will work. In particular, Martin's definition suggests that strategy necessarily involves a formula for generating customer revenue. So what does that mean for the finance function? Or for HR, or for IT? It means that for these functions, and for procurement, there can be no such thing as strategic behaviour.
Example three
Two Australian airlines operated in a duopoly servicing multiple airports across Australia. One of the airports that both airlines flew to only had one supplier of aviation fuel. The cost of aviation fuel at this airport was significantly higher than at the other airports where there was competition for the supply of aviation fuel. The two airlines cooperated to invite a new entrant to the market for aviation fuel at that airport. In return for investing in setting up operations at the airport, the two airlines agreed to guarantee a minimum volume of business to the new entrant for a period of time. The revenue guarantee would more than cover the fixed costs and the only requirement the airlines had is that the new entrant priced below the level of the monopolist.
Is this strategic behaviour?
I think it is strategic behaviour. The market has been changed through the actions of the two airlines. According to Martin's definition, this would not qualify as a strategy as it neither generates new customer revenues, nor does it help either airline 'win' as they both benefit equally. But what this example highlights is the difference between issuing a request for proposal and transforming the market. One is a market interaction and the other is a market intervention.
Market interaction
The overwhelming majority of what procurement practitioners do is not strategic. That does not mean it isn't important or that we shouldn't plan what we're going to do and how we're going to do it. However, we cannot really argue that example number one is strategic behaviour. At best, it may be tactical, and it will normally be operational.
Market intervention
A market intervention is something that either changes the structure of the market (like in example three) or changes the orientation of one or more providers in the market towards the client. The key point is that after the intervention the market is different at least for one of the clients in the market.
ChatGPT > Roger Martin
The essence of the distinction is that ChatGPT classifies the alignment of operational behaviour to the organisation's overall goals and objectives as strategic. Martin sees strategy and strategic behaviour as exclusively measured in terms of business strategy. It is concerned with the markets in which the organisation operates, its formula for success and how it intends to win. There is not much scope for 'strategic procurement'.
Let's go back to example three. Imagine that the two airlines found operating at that airport to be marginal in terms of profitability because the monopoly supplier of Jet A1 charged a premium. It is not unreasonable to suggest that one or both might withdraw from servicing that airport on the grounds it was no longer profitable. Given airlines compete on multiple dimensions including the extent of their network, we can see that the intervention to reduce the cost of Jet A1 at that airport helps support and contribute to the organisation's overall goals by sustaining the ability of both providers to service the traveling public.
Big shopping or strategic procurement?
Nobody wants to reclassify the 'Strategic Procurement Department' as the 'Tactical Procurement Department' (or worse the ‘Big Shopping Department’!) But if we are honest about being strategic or behaving strategically, we need to do two things. Firstly we need to align what we do to the goals of the organisation. Secondly, we need to identify which parts of the spend portfolio are most significant and consider how we can secure unique advantages for our organisation that are not available to our competitors. Market interactions are unlikely to achieve that distinction. So what can we do to intervene into the market to create genuine competitive advantage?
What is "strategic" about strategic procurement? Paul Rogers started work when the default name for the function was 'purchasing'. Here Paul tries to distinguish whether anything procurement practitioners do qualifiers for the adjective 'strategic'.
One of the fascinating things about the evolution of the procurement function is the emergence of the word 'strategic' as an obligatory adjective to describe everything that we do. Gone are the days when departments were merely procurement departments. Now they are proudly labelled as 'strategic procurement'. What was once a 'procurement plan' is transformed into a 'strategic procurement plan', in the same way that a tadpole metamorphoses into a butterfly.
The ubiquitous use of the word 'strategic' raises the question; 'what exactly is strategic about procurement?' As I am hip to the happening vibe, I did what all self-respecting practitioners would do and raised that prompt with ChatGPT. The response was:
"Strategic procurement involves more than just buying goods or services; it involves aligning procurement decisions with the organisation's overall goals and objectives."
So the paragraph in the RFP for office supplies that is headed "background" transforms what would otherwise be a routine operational market enquiry into a strategic act? An article in the Harvard Business Review by Roger L. Martin has argued that a plan is not a strategy. Martin argues that many practitioners mistake planning for strategy and suggests that they are completely different things. Martin's definition means that nothing that procurement practitioners do can possibly be strategic. His article directly challenges the conventional wisdom replicated by ChatGPT. Let's look at some practical examples to explore the issues.
Example #1
A ‘strategic’ procurement department prepares and issues a request for proposal for office supplies. On receipt of the responses, they shortlist the two lowest bidders for subsequent negotiation and select the provider who performed best against their evaluation framework. Is this strategic behaviour? I think the answer has to be 'no'. It is an operational activity following prescribed rules, processes and policies and is unlikely to have any significant impact on the organisation's performance.
Example #2
Many years ago, I was at a procurement conference and the Chief Procurement Officer of one of the world's largest corporations explained that senior managers at the organisation had no idea what the word 'sourcing' meant.
She told them that "it is the equivalent of shopping."
"Oh, they said, now we understand. So what is strategic sourcing?
"Big shopping!" she replied.
Cue audience laughter. I didn't laugh. At the time I thought she was completely wrong, but now I think she may have been correct. In what sense is consolidating variety, harmonising specifications, aggregating volumes and issuing a competitive enquiry, strategic behaviour? I get that there may be a some influencing and change management to get to that point, but isn't that what managers are paid to do? How is that strategic?
The World according to Roger Martin
Martin claims strategy is:
"...an integrative set of choices that positions you on a playing field of your choice in a way that you win."
Martin argues that you can prove in advance that a plan will work but that you can't prove in advance that a strategy will work. In particular, Martin's definition suggests that strategy necessarily involves a formula for generating customer revenue. So what does that mean for the finance function? Or for HR, or for IT? It means that for these functions, and for procurement, there can be no such thing as strategic behaviour.
Example three
Two Australian airlines operated in a duopoly servicing multiple airports across Australia. One of the airports that both airlines flew to only had one supplier of aviation fuel. The cost of aviation fuel at this airport was significantly higher than at the other airports where there was competition for the supply of aviation fuel. The two airlines cooperated to invite a new entrant to the market for aviation fuel at that airport. In return for investing in setting up operations at the airport, the two airlines agreed to guarantee a minimum volume of business to the new entrant for a period of time. The revenue guarantee would more than cover the fixed costs and the only requirement the airlines had is that the new entrant priced below the level of the monopolist.
Is this strategic behaviour?
I think it is strategic behaviour. The market has been changed through the actions of the two airlines. According to Martin's definition, this would not qualify as a strategy as it neither generates new customer revenues, nor does it help either airline 'win' as they both benefit equally. But what this example highlights is the difference between issuing a request for proposal and transforming the market. One is a market interaction and the other is a market intervention.
Market interaction
The overwhelming majority of what procurement practitioners do is not strategic. That does not mean it isn't important or that we shouldn't plan what we're going to do and how we're going to do it. However, we cannot really argue that example number one is strategic behaviour. At best, it may be tactical, and it will normally be operational.
Market intervention
A market intervention is something that either changes the structure of the market (like in example three) or changes the orientation of one or more providers in the market towards the client. The key point is that after the intervention the market is different at least for one of the clients in the market.
ChatGPT > Roger Martin
The essence of the distinction is that ChatGPT classifies the alignment of operational behaviour to the organisation's overall goals and objectives as strategic. Martin sees strategy and strategic behaviour as exclusively measured in terms of business strategy. It is concerned with the markets in which the organisation operates, its formula for success and how it intends to win. There is not much scope for 'strategic procurement'.
Let's go back to example three. Imagine that the two airlines found operating at that airport to be marginal in terms of profitability because the monopoly supplier of Jet A1 charged a premium. It is not unreasonable to suggest that one or both might withdraw from servicing that airport on the grounds it was no longer profitable. Given airlines compete on multiple dimensions including the extent of their network, we can see that the intervention to reduce the cost of Jet A1 at that airport helps support and contribute to the organisation's overall goals by sustaining the ability of both providers to service the traveling public.
Big shopping or strategic procurement?
Nobody wants to reclassify the 'Strategic Procurement Department' as the 'Tactical Procurement Department' (or worse the ‘Big Shopping Department’!) But if we are honest about being strategic or behaving strategically, we need to do two things. Firstly we need to align what we do to the goals of the organisation. Secondly, we need to identify which parts of the spend portfolio are most significant and consider how we can secure unique advantages for our organisation that are not available to our competitors. Market interactions are unlikely to achieve that distinction. So what can we do to intervene into the market to create genuine competitive advantage?
To fail to plan
April 04, 2024
“You can’t steer a ship by looking at its wake!”
“A good plan today is worth more than an excellent plan tomorrow!”
“To fail to plan is to plan to fail!”
“You can’t steer a ship by looking at its wake!”
I thought that a few aphorisms would be a good introduction to a presentation about procurement planning. I was wrong. After the presentation, a man approached me.
“Actually,” he announced, “if all your instruments fail when you’re on a ship, the only way you can successfully steer the vessel is by looking at its wake.” it is possible that he had a point. If the future is so dynamic and so difficult to predict as to make any forecasts pointless, maybe relying on what has worked before is the only option?
Here’s one I prepared earlier
Look back at the procurement plans that you have been involved with. How many of them took the previously-used document and updated the timetable? Isn’t that 'steering the ship by looking at its wake?'
Four types of planning
I think there are four types of planning that are relevant to procurement;
• Forward planning
• Contingent planning
• Preventative planning
• Scenario planning
The truth is that the contemporary workplace squeezes out opportunities for thinking in general and envisioning in particular. How can we claim to be strategic if our time horizon is focused on getting the RFP out by Friday rather than “what will the market be like in 18 months time?”
Forward planning
Forward procurement planning is typically focused on the following four topics;
• The RFP process and timetable
• The evaluation process and timetable
• The contract timetable
• Known and potential market dynamics
Whether your forward plan for a significant spend is called a “procurement plan“ or a “category plan“, it Is likely to contain a timetable for market engagement. When will the bids go out and when are the bids due back? Having insisted on ten days for bid submission, it is a truth universally acknowledged that sometime during the scheduled evaluation process, the procurement team will announce to the bidders that “evaluation is taking longer than we expected!” . It is my experience procurement people like you and me routinely underestimate how long it takes to evaluate offers. Could this be a symptom of poor planning?
The contract timetable includes the interval between contract award and contract commencement, the primary period and the number and duration of any optional contract extensions. I once asked a senior procurement manager why the office supplies contract had a duration of one year plus two optional contract extensions each of two years. “That’s easy, if the contractor is rubbish, we can kick them out after a year!” I hope the rationale for the duration of the initial contract period is based on better logic than that! Consider the payback period on any customer specific investments that the contractor has to make, or the cost of change, or even the dynamism of the market.
Market dynamics is the final topic for forward planning. This might include synchronising the expiry of different agreements within the organisation in order to consolidate like requirements. Or perhaps a provider of a legacy solution is withdrawing support at a known future milestone. Or there are future regulations coming which impose new obligations.
My rule-of-thumb when reviewing procurement plans is to sum the number of words in the topics in the first three bullet points listed above, and divide that by the number of words in the fourth topic. If the answer is greater than procurement’s magic number- three- then this may point to an operational plan, rather than a more “strategic” plan.
At the very least procurement plans should include content dealing with known drivers of change that will make tomorrow different to today. The reality for all of us is that the time horizon over which we can confidently anticipate the future is getting shorter. But that doesn't mean we shouldn't try.
Contingent planning
Contingent planning is the “if this happens, then we will do that” thinking that informs disaster recovery and business continuity plans. The lessons learned from recent supply chain disruptions is that it is good practice to monitor leading indicators of change so we can execute a pre-prepared plan immediately that a trigger event is detected. If “Supply chain resilience” is an important priority for you, then having the contact details of alternate suppliers, or having access to safety stock may be examples of a contingency plan.
The key steps are
• identify potential sources of supply chain disruption;
• consider what may be the direct and indirect consequences;
• develop a contingency plan to a level of detail so it can be executed immediately;
• identify leading indicators of potential disruption;
• assign responsibility for monitoring the leading indicators;
• define the authorising chain to enact the plans at short notice.
Preventative planning
A packaging executive once told me about how starch was a vital ingredient in making cardboard boxes. Apparently, manufacturers of cardboard boxes played off the three starch suppliers in the Australian market against each other. Eventually, one of the starch suppliers left the market as margins were unsustainable and demand unpredictable. The big buyers of starch continued to play tactical price games, and the two remaining suppliers continued to complain about sustainability. Eventually, one of the two remaining suppliers exited the market. You don't need me to tell you what happened next, do you?
Preventative planning might have involved the buyers of starch ensuring that there was sufficient capacity in the market to meet their needs, without falling foul of the market regulator. Perhaps dual sourcing might have been appropriate? Or underwriting some of the supplier's fixed costs? Preventative planning requires risk focused prescience of what might happen, and taking steps beforehand to reduce the likelihood of the risk happening. You wouldn't entrust a strategic negotiation to someone with no negotiation capability, would you?
Scenario planning
It is sometimes said that scenario planning is undertaken in order to give horoscopes a good name. "Tomorrow will be like yesterday, only with hoverboards!" For procurement practitioners this translates into modelling "what might happen in the evolution of the supply market?" Nominate a facilitator and a sage.
• The sage identifies a specific macroeconomic or market change;
• the facilitator asks "what happens next?";
• the sage identifies a number of likely consequences;
• for each of the consequences, the facilitator asks "why does that happen?", and "what happens next?";
• the sage continues exploring follow-on direct and indirect consequences;
• do this for five or six cycles and add a label for the scenario;
• then the team review the unfolding events, the linkages and the outcome.
After two or three iterations with different trigger events, the team will have explored some possible futures and built understanding of market processes and inter-relationships. When developing category plans, if the intended strategy would fail under any of the possible futures, then it may need to be revised to make it more robust.
Conclusion
I hope your instruments haven't failed! Challenge yourself and your team to make time to plan, and make sure you are not navigating by looking at the ship's wake.
“A good plan today is worth more than an excellent plan tomorrow!”
“To fail to plan is to plan to fail!”
“You can’t steer a ship by looking at its wake!”
I thought that a few aphorisms would be a good introduction to a presentation about procurement planning. I was wrong. After the presentation, a man approached me.
“Actually,” he announced, “if all your instruments fail when you’re on a ship, the only way you can successfully steer the vessel is by looking at its wake.” it is possible that he had a point. If the future is so dynamic and so difficult to predict as to make any forecasts pointless, maybe relying on what has worked before is the only option?
Here’s one I prepared earlier
Look back at the procurement plans that you have been involved with. How many of them took the previously-used document and updated the timetable? Isn’t that 'steering the ship by looking at its wake?'
Four types of planning
I think there are four types of planning that are relevant to procurement;
• Forward planning
• Contingent planning
• Preventative planning
• Scenario planning
The truth is that the contemporary workplace squeezes out opportunities for thinking in general and envisioning in particular. How can we claim to be strategic if our time horizon is focused on getting the RFP out by Friday rather than “what will the market be like in 18 months time?”
Forward planning
Forward procurement planning is typically focused on the following four topics;
• The RFP process and timetable
• The evaluation process and timetable
• The contract timetable
• Known and potential market dynamics
Whether your forward plan for a significant spend is called a “procurement plan“ or a “category plan“, it Is likely to contain a timetable for market engagement. When will the bids go out and when are the bids due back? Having insisted on ten days for bid submission, it is a truth universally acknowledged that sometime during the scheduled evaluation process, the procurement team will announce to the bidders that “evaluation is taking longer than we expected!” . It is my experience procurement people like you and me routinely underestimate how long it takes to evaluate offers. Could this be a symptom of poor planning?
The contract timetable includes the interval between contract award and contract commencement, the primary period and the number and duration of any optional contract extensions. I once asked a senior procurement manager why the office supplies contract had a duration of one year plus two optional contract extensions each of two years. “That’s easy, if the contractor is rubbish, we can kick them out after a year!” I hope the rationale for the duration of the initial contract period is based on better logic than that! Consider the payback period on any customer specific investments that the contractor has to make, or the cost of change, or even the dynamism of the market.
Market dynamics is the final topic for forward planning. This might include synchronising the expiry of different agreements within the organisation in order to consolidate like requirements. Or perhaps a provider of a legacy solution is withdrawing support at a known future milestone. Or there are future regulations coming which impose new obligations.
My rule-of-thumb when reviewing procurement plans is to sum the number of words in the topics in the first three bullet points listed above, and divide that by the number of words in the fourth topic. If the answer is greater than procurement’s magic number- three- then this may point to an operational plan, rather than a more “strategic” plan.
At the very least procurement plans should include content dealing with known drivers of change that will make tomorrow different to today. The reality for all of us is that the time horizon over which we can confidently anticipate the future is getting shorter. But that doesn't mean we shouldn't try.
Contingent planning
Contingent planning is the “if this happens, then we will do that” thinking that informs disaster recovery and business continuity plans. The lessons learned from recent supply chain disruptions is that it is good practice to monitor leading indicators of change so we can execute a pre-prepared plan immediately that a trigger event is detected. If “Supply chain resilience” is an important priority for you, then having the contact details of alternate suppliers, or having access to safety stock may be examples of a contingency plan.
The key steps are
• identify potential sources of supply chain disruption;
• consider what may be the direct and indirect consequences;
• develop a contingency plan to a level of detail so it can be executed immediately;
• identify leading indicators of potential disruption;
• assign responsibility for monitoring the leading indicators;
• define the authorising chain to enact the plans at short notice.
Preventative planning
A packaging executive once told me about how starch was a vital ingredient in making cardboard boxes. Apparently, manufacturers of cardboard boxes played off the three starch suppliers in the Australian market against each other. Eventually, one of the starch suppliers left the market as margins were unsustainable and demand unpredictable. The big buyers of starch continued to play tactical price games, and the two remaining suppliers continued to complain about sustainability. Eventually, one of the two remaining suppliers exited the market. You don't need me to tell you what happened next, do you?
Preventative planning might have involved the buyers of starch ensuring that there was sufficient capacity in the market to meet their needs, without falling foul of the market regulator. Perhaps dual sourcing might have been appropriate? Or underwriting some of the supplier's fixed costs? Preventative planning requires risk focused prescience of what might happen, and taking steps beforehand to reduce the likelihood of the risk happening. You wouldn't entrust a strategic negotiation to someone with no negotiation capability, would you?
Scenario planning
It is sometimes said that scenario planning is undertaken in order to give horoscopes a good name. "Tomorrow will be like yesterday, only with hoverboards!" For procurement practitioners this translates into modelling "what might happen in the evolution of the supply market?" Nominate a facilitator and a sage.
• The sage identifies a specific macroeconomic or market change;
• the facilitator asks "what happens next?";
• the sage identifies a number of likely consequences;
• for each of the consequences, the facilitator asks "why does that happen?", and "what happens next?";
• the sage continues exploring follow-on direct and indirect consequences;
• do this for five or six cycles and add a label for the scenario;
• then the team review the unfolding events, the linkages and the outcome.
After two or three iterations with different trigger events, the team will have explored some possible futures and built understanding of market processes and inter-relationships. When developing category plans, if the intended strategy would fail under any of the possible futures, then it may need to be revised to make it more robust.
Conclusion
I hope your instruments haven't failed! Challenge yourself and your team to make time to plan, and make sure you are not navigating by looking at the ship's wake.