Why was Elon Musk (or your CEO) late for an interview and other procurement problems. Economics to the rescue.
Look the below video for the first 3 minutes and 45 secs and you will know why Elon Musk was late for his interview with Khan Academy’s Sal Khan.
Welcome back, if you remember the first 4 minutes (we know you watched more) you might put this down an irresponsible supplier, myopic planning, Murphy’s Law or even karma. But the issue might more a problem of incentives and perspective.
Before we dive into the solution would like to mention, we have no working relationship any of the companies or people mentioned throughout the entire series. We are simply using a publicly available information as an example to discuss a possible framework.
It’s not just about reduced costs
We are making some assumptions to define the problem. We think the problem is not about a single event but about the perspective and incentive gap between the buyer and supplier. The purchase mentioned in the video was probably low value, (we assume a car maker is not the largest buyer of USB cables) making it lower priority and lower risk for the supplier.
Such a situation would prompt the supplier to find ways to cut costs, like for example using a lower cost shipping method as was done here.
However, it the procurement event was business critical for the buyer. A simple focus on negotiated cost savings might have an adverse impact on business risk. So how should a procurement professional identify such events approach them to minimize business risk?
Economics to the rescue
First, identify procurement events and how business critical they are, where they fall in the supply chain and dependencies. You may notice a gap between critical and high-value events.
Another important perspective to consider is how the supplier would view the procurement event. Does the supplier view it as high-value?
Now look the below decision chart below. Plot each purchase event in the appropriate place and this would make it easy for you to understand incentives for each procurement event. The incentives the fall within equilibrium band usually have a have a lower risk of failure because both parties have equally motivated.
But in the case of procurement events that do not fit into this band, there are opportunities and risks.
The real risk for the buyers is under the equilibrium band, where the supplier does not view the event as important or high risk. To mitigate the risk of the buyer should essentially
– Speed up decision making to avoid delays
– Overstock or in rare cases even overpay to increase deal value or margins for suppliers
– Reorganize / rationalize suppliers to combine low value, critical purchases from a larger and fewer suppliers
– Increase collaboration between procurement teams and manufacturing / operations. An effective procurement organization cannot work at an arm’s length from the project or manufacturing teams – there should be very close synergy between the two teams starting right from the product planning stage
– Communicate the priority across the value chain – While this is a basic step, procurement managers often avoid doing this as they too assume low value equals low priority or don’t want to lose the upper hand during negotiations.
If you think taking all of the above steps might have an adverse impact on costs the other end of the spectrum provides opportunities and a favorable trade-off
All procurement events below the equilibrium line are low value. This means the financial impact is limited the favorable impact on risk mitigation is high. At the other end of the spectrum, above the equilibrium line, there is an opportunity to save costs.
Here procurement professionals can have a greater positive impact on higher value procurement events which are tactical and not critical to business operations.
They can do this by
- Negotiating harder and longer and delivering high impact value.
- Deploying reverse auctions can be very used effectively to drive down increase competition and get better rates. This is especially relevant the buying a commodity or commoditized product or service.
However, the key is to correctly identify non-critical events as non-critical and the best way to that is by increasing procurement’s connect with the business teams and develop category expertise within procurement teams.
We hope this simple framework inspired by inspired by incentive economics can help procurement professionals deliver value and reduce business risk where it is at its highest.
Aspects of the Zycus’ source-to-pay suite can help you categorize and analyze procurement events from a non-cost perspective. Contact us here to know more.
This is the 3rd in our series of posts on Practical Procurement where we look at real world events and their impact on procurement and business. You can find the 1st post about Apple’s Chipgate and dealing multiple suppliers here and the 2nd post which is which provides a CPOs guide to Product Recalls here.
Once again thanks, to my colleague and Product Management Director at Zycus, Kanishka Ghosh for his invaluable inputs, if you like the posts in this series, it large a result of his inputs.
Like this post or have something to add, give us a shout out in the comments section below. We would love to hear from you.