Super Crunchers ...

These two are the super crunchers in my life ... followed by what they thought of Ian Ayres' book ... I'll let you know what I think about it myself if there is enough left to read ...

What's the number?

I've negotiated a fair number of contracts over the years. Most of the time its a simple exercise of determining the how much will one pay for a good or service. But when the transaction is extended in time or over a number of payments even the simplest transaction can become difficult to conclude. I've found that one of the biggest issues is a disconnect between what is emotionally fair, and what is numerically reasonable.

Let's take a car purchase. A dealer has it listed at $38,789 after some negotiation you settle on a price of $35,600. The dealer then asks if you would like to finance the car over 6 years, and offers to do so at $702/month. Is that a good deal? In order to decide you need to be able to calculate some numbers, and have some external information. One piece of information you need is "what interest rate would someone charge me to borrow $35,600 and repay the loan over six years?"

In this case, the answer depends on whether you can get someone else to write this loan for less than 12.3%. All in all, these are not difficult calculations (and any number of web-sites, calculators, or spreadsheets will perform them for you).

However ... when you are negotiating procurement or outsourcing contracts don't assume all the parties at the table will be able to perform these calculations - especially "right there at the table" and that even if they can, that they will think the result is reasonable.

I'm often surprised at how frequently clients (and sales staffs) get tied up on this issue when services are paid on a deferred basis. You will often see sales staff asking for outrageously high margins just as often as you'll find a client wondering why they can't pay, for example, $1M in 10 years for $1M in services today.

And just when you think everyone is on the same page and being all reasonable, then we need to consider deal and partner specific risk ...

Cheers,

David Rotor

Mean or Green?

This weeks Economist has an article, Tilting at Windmills, that discusses the boom in investing in renewable energy technology companies. There are some interesting comments, including a reasonable one that suggests $50/barrel for crude oil is the tipping point that makes alternative energy viable, we've been at that price since early 2005.

This thought process, "at what point does it make economic sense to invest in a substitute product sector?" should be a pretty common piece of analysis in the corporate procurement world.

In the spring of this year I spoke to several hundred members of a material management organization that is largely made up of government sector buyers. It was an interesting experience as they work in a sector where policy often trumps reason. The range of policy objectives and interest groups that are factored into procurement decisions include small business, green procurement, aboriginal business, regional diversity, industry lobby groups, linquistic diversity, industrial policy, safety standards, etc. I challenged the group to consider which of these policy objectives could be supported through cost/benefit or other economic analysis.

In many cases "green procurement" can and does make good procurement sense. Here are a few examples:

• a well-known global clothing retailer saved over 50% of their waste removal costs by removing cardboard (OCC) from the waste stream and generating revenue from recycling
• Low-rise commercial buildings can install various technologies to pre-condition air prior to it reaching the roof-top HVAC unit. Typically these are heat-exchange units that capture the thermal value of outgoing chilled or heated air (depending on the season) prior to expelling the air. Economic payback is often 3-5 years, while government subsidies often substantially shorten that period.
  
• including VPN capability into your secure network design adds cost, but it can enable staff to work from home, cascading into lower facility costs, and incidentally removing some carbon load from commuter traffic
• In many office environments there is little thought given to the number and capacity of the printers and copiers. A recent study I looked at for two multi-story office towers showed that there were about 30% too many printers and copiers. Not only does this mean capital and maintenance costs are higher than necessary, there is a two-order impact on energy consumption. First the surplus machines consume energy, and second they generate substantial heat that requires additional energy to cool the office environment.
  

In every procurement decision I look at, I encourage the team to consider the entire "life cycle" cost of their decisions. What constitutes the entire life cycle cost is a whole other topic.