Penny wise procurement strategies-long-term-effectiveness-short-term-wins 1012-1

Penny wise procurement strategies-long-term-effectiveness-short-term-wins 1012-1

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  Procurement strategies that deliverlong-term effectiveness over short-term wins This paper discusses the concept of‘short-term financial gains’ at the cost of‘long-term sustainability’, which is demonstrated by the saying‘penny wise, pound foolish’. The premise is that there is a need to avoid short-term procurement strategies during financial crises, which could compromise long-term success. The paper’s central theme is built around the popular management model Porter’s 5 Forces, and we correlate the theories in this model to the real world challenges of procurement and how they can provide a long-term cost efficient solution. In addition to applying these theories to current procurement situations, we provide points for discussion on applying these within organizations. We have also presented a list of recommendations based on our studies and findings into the applicability of this theory. White Paper
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  2 About the Authors DrGordon Murray Dr Gordon Murray is a strategic procurement specialist within the Global Consulting Practice of TCS. He holds an MSc with Distinction in Purchasing & Supply Management, a PhD in strategic procurement improvement, and is a Corporate Member of the Chartered Institute of Purchasing & Supply. His career, prior to joining Tata, included 25 years as an award winning procurement practitioner, 11 years on national procurement improvement initiatives, and lecturing. He has been described as a "very experienced procurement practitioner, consultant, academic and writer" "influential procurement twitter" and "excellent blogger". His academic work has been published in leading international procurement journals such as Supply Chain Management: An International Journal; Journal of Purchasing & Supply Management; International Journal of Public Sector Management; Public Money and Management: and, Journal of Public Procurement. Rizwan Imtiazi Rizwan Imtiazi is a Senior Consultant within the Global Consulting Practice of TCS providing procurement operations expertise. He holds a MBA in Purchasing & Supply Management and has worked within a diverse range of industries and categories over a 17 year career. Some key Procurement projects he has been involved in include the London 2012 Olympics and the largest infrastructure project in Europe called Crossrail. Rizwan is the founder of ESCIC, the first forum bringing together the key players in the construction industry to address ethical sourcing of construction materials and equipment. He was its Chairman providing strategic vision and direction until leaving Crossrail in March 2012.
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  3 Table of Contents 1.Introduction 4 2. What does theory suggest 4 we should practice? 3. Understanding the 5 Forces Model 5 4. Environmental Scanning 5 5. The Current Procurement Environment 5 6. Discussion and Conclusions 7 7. Recommendations 8
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  Introduction What does theorysuggest we should practice? At Tata Consultancy Services we have been considering how firms can most effectively use procurement in their response to the current economic crisis. In this paper, we caution on the need to avoid short-term strategies that may be detrimental to long-term effectiveness. We draw on the theory of the Porter’s 5 Forces Model, and apply that to real-life procurement strategy. We then discuss concerns and challenges, prior to making recommendations to help you avoid being ‘penny wise and pound foolish’. Over 5.5M results were found in a 'Google images' search for Porter's 5 Forces Model. The Model is considered so fundamental to strategy that countless hours are spent at Business Schools forcing it into future business leaders’heads. However, we speculate that using the Model as a tool for pragmatic analysis, development and review of strategy has been cast aside like the mortar boards thrown to the wind in pre-Health and Safety constrained days. Is Porter’s 5 Forces Model relevant or just a set piece of Business School theory? Would your strategy change if the Model was applied as a continuous decision- making tool? Are you avoiding being‘penny wise and pound foolish’? 4 Figure 1: Porter’s 5 Forces Model Suppliers Buyers Substitutes Potential Entrants Industry Competitors Rivalry among existing firms Threat of New Entrants Bargaining Power of Buyers Threat of Substitute Products or Service Bargaining Power of Suppliers
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  5 We use Porter’s5 Forces Model as a foundation and conclude that if the Model were used strategically, some of the strategies currently being pursued may justify a rethink. Our rationale is that consistent use of the Model in all businesses, beyond a short-term horizon, helps identify weaknesses of current strategy and the adverse impact on long-term strategy. Consider using the 5 Forces Model in terms of developing a procurement strategy. First we need to understand that the buying firm is in the middle. The buying firm supplies to its customers and clients - its buyers. The 'threat of substitutes' relates to the firm’s customers finding an alternative product or supplier so that they no longer buy from the firm. While the‘bargaining power of buyers’and‘threat of new entrants’and‘substitutes’should be uppermost in the minds of the marketing manager, the latter two should have a bearing on how the procurement manager and their advisers think and help in framing the procurement strategy. When we refer to the firm's procurement strategy, the 'bargaining power of suppliers' relates to the firm’s suppliers. The 'threat of new entrants' relates to potential new entrants which the firm’s existing customers could draw on (displacing the firm); but just as easily, it can address how potential new entrants to the market could disturb the bargaining power of the firm’s suppliers and enable it to source elsewhere. The procurement manager would want to reduce the barriers to entry for potential new suppliers and in so-doing increase choice, potential new sources and healthy competitiveness within the market. Equally, when we refer to the threat of substitutes, we can view that as potential new products and innovations that could make the firm more competitive and replace the 'old specification'. Being able to accomplish this would entail on-going environmental scanning on the part of the procurement manager. Research was carried out a few years ago on the impact of the economic crisis on procurement strategy. We were amazed to note that the overwhelming response of those who responded was that they hadn't changed their procurement strategy; on-going environmental scanning appeared to be a theory as opposed to a practice. Five years into the crisis, we wonder if the same situation prevails. Theory suggests that the 5 Forces Model provides a useful structure for on-going analysis of the findings of environmental scanning. However, what we consider is whether a short-term approach to procurement strategy may well be detrimental to long-term strategic want to objectives. Given the theory of the 5 Forces Model and the need for continuous environmental scanning, we now consider the current environment which many organizations find themselves in. In the short-term, suppliers are under working capital pressure and cannot access credit. They are thus at risk of going into liquidation. If they are a supplier on whom the buyer is dependent, that in turn increases the buyer's risk profile. To mitigate against the increased risk, the buyer can opt for multiple sourcing. Understanding the 5 Forces Model Environmental Scanning The Current Procurement Environment
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  6 From the supplier'sperspective, any shift by the buyer to a multiple sourcing approach, say dual sourcing, means the supplier will have even less demand from the buyer, therefore increasing the supplier's risk - a vicious circle of risk amplification. Assume the buyer is clear that their primary short-term strategic objective is cost reduction. That translates to strategies of 'reduce transaction costs' and 'pay less'. The buyer's knee-jerk reaction is to place more pressure on suppliers and expect them to 'sharpen their pencils’. There is a shift towards adversarial and competitive sourcing; effectively dismantling the partnership ethos advocated since the 1990s. The buyer exerts all the available pressure on the supplier. The supplier needs the business, so accepts the need to price on marginal costs in the hope that fixed costs can be recovered from more benevolent buyers who are taking a longer-term perspective. This also exerts additional pressure on the supplier’s agents to match their sales volumes targets. So effectively, the supplier is selling at a non-sustainable price, one that just isn’t economically viable. With both the supplier and the buyer adopting short-term strategies, a long-term consequence could be, at best an exit of suppliers from the market, leaving a long- term monopoly and shift of power from the buyer to the supplier. At worst, the outcome could be a failure of the buyer organization to source what is required to satisfy its customers. Separately, given the short-term pressure on suppliers, they can be expected to defer their own investment in both research and development and in production assets. Not only will they‘park’R&D but they will try to extend the life of their kit, say sequencing an extra few years. (We recently worked with one organisation that should have replaced their operational equipment after five years but due to 'austerity' had stalled replacement and stretched the life of the equipment to eight years; the problem was they were incurring additional maintenance costs and their delivery was compromised, leading customers to shift to alternative providers.) The buyer may of course feel this will not impact them until they recognize that suppliers’investment in R&D is an investment that benefits the buying organization in reduced costs and innovation. So, while the buyer may have a short-term gain, they face a long-term cost too. If we place this in a global context, we could ultimately be creating ingredients that obstruct a national industrial strategy. Now let’s consider the threat of new entrants. We have discussed that removal of entry barriers should be of benefit to the buyer. However, the current economic environment is itself a barrier to new entrants - something buyers have little control over. If there is a lack of new entrants to the buyer’s market, the buyer is starved of choice. This scenario exacerbates the adverse impact of existing supplier failure. When we think of the threat of substitutes, we can view that in the context of alternatives to our existing specifications. Once again we have an interesting dynamic. Is the current environment creating the right circumstances for experimenting with new specifications? Ironically, that is likely to depend on the risk appetite of the buying organization. Some organizations will be risk averse and resist experimentation; others will welcome the potential for cost reduction and enhanced customer experience. The stakes are high - will that be thrashed out in the procurement strategy?
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  7 Discussion and Conclusions Whilebuyers and suppliers are mutually dependent, our concern is that current procurement responses to the on-going economic crisis, may well be naïve and lack the rigor of thinking through the long-term consequences. A short-term opportunistic procurement strategy could lead to: A reversion from partnerships to adversarial competitive approaches; A detrimental reversion to 'price' based procurement; Buyer and supplier risk increased and a self-amplifying vicious circle; Unaffordable pricing by suppliers which delivers a short-term gain to buyers but supplier failure and ultimately the buyer having no supply source; A lack of new entrants to the market; An increase in monopolies with a shift of power from the buyer to the supplier; Loss of investment in supplier R&D which ultimately results in a loss of innovation through procurement and the loss of the buying organization's competitiveness; A dilemma of whether or not it makes sense to experiment with new specifications. A short-term focus could lead procurement to ultimately compromising the long-term success of the firm and even the supply chain. Quite simply, we could be creating dynamics that work against the buyer when we reach the economic recovery; short-term gain leading to long-term loss. Or, in common parlance, being‘penny wise and pound foolish’. The current financial crisis has the potential for procurement to demonstrate its real strategic contribution. The profession stands on the edge of opportunity - but could that opportunity, wrongly grasped, become procurement's nemesis? We feel that currently dominant procurement strategies suggest that Porter’s 5 Forces is not being considered in the longer-term. While our discussion is highly conceptual we feel it acts as a timely wake-up call; a wake-up call to both practitioners and their advisers. n n n n n n n n
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  8 Recommendations Having considered thelisted scenarios, which we believe present real risks to organizations, we present our recommendations. Ask when your strategy was last reviewed and consider the need for a refresh; Ensure your procurement strategy is strategically aligned with the outcomes your organization wants to achieve; Put in place a mechanism to ensure that on-going environmental scanning is taking place and that significant changes in the external environment, which could have an impact on your procurement strategy, are reported to the Board; Ask whether you have carried out due diligence of current strategic supplier security of supply; Ask whether your organization is encouraging a short-term approach to procurement objectives; Consider whether the longer-term risks associated with your short-term strategy have been appropriately identified and risk managed; While the current environment may well suit buyers, are you ensuring that your organization will still be a preferred supplier when economic recovery arrives; Ask whether you are pursuing a strategy which will create the right market structure when economic recovery has been achieved; Ask are your payment processes supporting or hindering supplier cash flow; Ask are you doing all that is required to shape a long-term market that suits your needs. n n n n n n n n n n
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