COMMODITY RISK MANAGEMENT
Equipped for a bumpy ride
Tom Bundgaard, Jon Hughes, Søren Vammen & Lasse Hvid-Jorgensen
Volatile commodity prices over the past three years have hit the bottom lines of many companies. But there are means by which CPOs can proactively prepare for and manage cost risk, say the authors, and they must now take action on three levels:
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A strengthening of enterprise-wide risk management.
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A reappraisal of supply chain and procurement risk management strategies.
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A focus on building new capabilities and applying innovative analytical tools in individual sourcing and commodity strategies.
The authors propose six broad generic strategies – such as redesigning specifications or offsetting losses with savings elsewhere – that can mitigate the adverse effects, while a further eight elements should form part of an ongoing commodity risk management strategy.
These include undertaking a value at risk analysis; dynamic forward planning; creating a dedicated commodity centre of excellence and conducting both a fundamental analysis into the current business cycle and a technical analysis based on current contracts and future price predictions. Hedging and other financial instruments can also be used to ensure that firms do not suffer unduly from price rises.
INTERVIEW: PETER KRALJIC
Reflections of a pioneer
Philip Usherwood and Dick Russill
In September 1983, Harvard Business Review published a ground-breaking article by Peter Kraljic that would shape the purchasing function as we know it today. Twenty-five years later, he talks to Philip Usherwood and Dick Russill about the origins of his thinking and its relevance now.
Working as a McKinsey consultant in the 1970s at a major chemical firm that found itself highly exposed to supply chain disruptions, Kraljic identified 70-80 major categories that required individually defined approaches. These delivered such competitive advantage that he was required to keep his model a secret. It would be 10 years before it was published.
Even now, Kraljic’s emphasis on risk and opportunities are not practised universally. He also argues that companies could do more to build relationships with suppliers when times are good. A greater emphasis on trust is one of two aspects that Kraljic would change with the benefit of hindsight. The other relates to his audience. “I would not address it to the purchasing community, but to the CEO,” he says. “They can uplift and anchor supply management.”
Usherwood and Russill also deliver their verdicts on the man and his article that set the direction for much of procurement’s development.
SUPPLIER RELATIONSHIP MANAGEMENT
The customer’s dilemma
John Henke
Many CPOs feel they have to choose between good working relations with suppliers and getting the lowest possible price, says Planning Perspectives’ John Henke. But is this really the case?
Henke examines the key features of co-operative supplier relationships – buyer communication and information sharing; buyer treatment of suppliers; and supplier trust of the buyer – and the extent to which these are affected by price pressure.
Research into the relations of 279 tier-1 suppliers with North American auto makers found that while there was a significant negative impact on the overall working relations when price reduction pressure was introduced, this became insignificant when supplier trust was increased. And, crucially, both are possible at the same time.
Further research suggests that the main determining factors for good supplier working relations are the company’s general treatment of the supplier and the degree to which the supplier feels involved in the customer’s day-to-day operations.
Long-term relationships based on trust are the only means by which suppliers will agree to price cuts while maintaining their current contribution to competitive advantage, Henke argues.
NEGOTIATION
Avoiding the three deadly sins
Tom Kinnaird and Hal Movius
The focus on strategic sourcing means that procurement professionals are unable to adopt a more sophisticated, value-creating approach to negotiation, argue WPP’s Tom Kinnaird and Hal Movius from the US-based Consensus Building Institute.
Drawing on many years of research on negotiating behaviour, they describe three “deadly sins” of value destruction. These are:
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The “unthinking application” of strategic sourcing and e-sourcing processes.
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Traditional negotiation that fails to consider mutual benefits and encourages parties to hold back information.
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Ignoring the value of relationships between internal stakeholders and suppliers.
CPOs, who need to be seen as value-creators first and procurement specialists second, should introduce negotiation training based around organisational needs, allow procurement teams to venture outside the strategic sourcing remit where justified, and introduce a new measure of success for supplier negotiation that moves beyond cost.
Such a focus would help to move procurement out of its process comfort zone and into a strategic business role. Only then can it shatter the stereotypes that continue to beset the profession.
GLOBAL SOURCING
The case for clusters
Roger Moser and Konrad Bänziger
Cost pressures have led many companies to pursue global sourcing policies, but they often lack the expertise and experience to take this to the next level. Roger Moser of the Supply Management Institute in India and Konrad Bänziger of BrainNet outline a more focused approach to deploying procurement resources using the analysis of “sourcing clusters”.
These are defined as “geographically proximate groups of connected companies and associated institutions in a specific region” and focus on a company’s specific supply needs. Clusters must be carefully selected and international procurement offices given time to develop them using local decision-making and spend authority.
The authors propose an approach that mixes local information with a long-term perspective to form the basis of decision-making, with indexes to measure a cluster’s “sourcing fit” and the company’s “sourcing expertise”. They illustrate how this works in practice using the example of a German automotive firm sourcing mechanical components.
They also outline the findings of research among 150 Indian sourcing managers into the relative merits of eight of the country’s major sourcing clusters.
INNOVATION
Reaching out for new ideas
Nicolas Reinecke, Khosro Ezaz-Nikpay and Shail Thaker
Many firms now “source” innovation from external parties, and research suggests that they achieve a higher return for shareholders than those that rely only on in-house facilities.
Successful innovators such as Apple, Procter & Gamble and Renault have created their own hotspots of innovation and source concepts, skills and technology from outside, say the authors. This puts procurement at the heart of the innovation process and demands new skills around sourcing ideas and knowledge rather than physical products and services.
CPOs need to deploy a collection of tools that can bring maximum advantage out of particular innovations through identifying potential opportunities, monitoring research and competitor activity, and working with partners to ensure products are launched successfully.
Category managers already have some of these skills, but they need enhanced problem-solving abilities, have the confidence to explore unconventional solutions, and be able to work closely with R&D and manufacturing functions.
If CPOs can get this right, procurement can become the main source of the majority of commercially significant products and services in many firms in the future.
SUPPLY MARKET INTELLIGENCE
Knowledge is power
Nick Martindale
Having detailed category information has never been more important. Such information means buyers can:
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be better prepared for supplier negotiations;
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benchmark suppliers against each other;
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gain a more telescopic view of their capabilities across multiple categories;
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give procurement more weight in discussions with internal customers.
The growing importance of market intelligence means that many organisations are having to look at the best way to capture and analyse it. The options open to CPOs are to outsource to one of a number of specialist research companies, many of which are based in low-cost countries, or to establish an in-house or offshore facility of their own.
Outsourcing is often the cheaper option, but the quality of information can vary wildly. As a result, firms such as BP and P&G have so far opted for the in-house route.
However companies choose to set themselves up, this is an issue that is set to grow in importance. Phillip Duncan, CPO at Novartis, for example, intends to make it a key part of his strategy for 2009. “At a buyer and category manager level, having good data and market intelligence is fundamental to doing the job properly,” he says.
