How much for an iPhone?

Over at Gizmodo they've posted a ton material on the iPhone. Here's one (they didn't write it) about the material cost of the iPhone. Bottom-line is an estimate of $200. "What if costing" is fundamental in procurement, and one of the main tenets of the technique is to understand what bits of the cost equation are you estimating and what, if any, relationship that has to pricing. With the iPhone retailing at $600 give or take, I would suggest that "what the market will bear" factored more heavily in the pricing discussions than the material costs. But even so, the guys at Giz suggest that consumers should be a bit taken back by Apple's profit. The real cost of the iPhone is probably somewhere north of $400, even without allocating any development costs to the product.


Material cost
Logistics (transportation, handling, inventory)
Retail costs (labour, facilities)
Advertising & Marketing
Support costs (how do I activate this dang thing?)
Warranty costs (shipping, handling, labour, parts)
etc, etc

Rough numbers, this type of equipment often runs about 50% material and 50% other costs (again not counting any development costs). Is $600 a fair price for a $400 phone? My buddy Mike says yes, and who is a lowly buyer to argue with that?

Cheers,

David Rotor

Shared savings?

I'm working on a few investment opportunities that have come up for this fund. The fund is, obviously, interested in the mechanism for shared savings and while we are starting with a bias on how the funds would flow it's been useful to work through some other scenarios.

We're exploring five shared savings models:

1. Identified Savings
2. Front End Rebates
3. Back End Rebates
4. Transaction Payments
5. Periodic Payments

Identified Savings
This is commonly used by strategic sourcing consultancies that have contingent savings contracts with their clients. Savings are "identified" but not realized prior to payment. Often the milestone for payment is at the time of awarding a contract to a supplier that provides lower costs for a good or service.

Front-end Rebate
In this model the supplier takes on the future purchased volume risk in a contract and pays the client their savings at time of contract award.

Back-end or Volume Rebate
In this model the supplier pays the rebate at some pre-determined point in time, such as quarterly, annually, or at contract expiration. This is normally defined either as a lump-sum payment (thereby having the supplier hold the purchased volume risk) or as a volume related payment (thereby having the client hold the purchased volume risk.

Periodic Payments
Savings are tracked and paid on a periodic basis (often monthly or quarterly). While there can be multiple mechanisms this form of shared savings are managed they are usually based on tracking the volume of purchases over the defined period and applying a savings formula to that volume.

Transaction Payments
Savings are tracked and included in the transaction. Payments are made coincidental with supplier payments for each relevant transaction.

Sit down and read this

Procurement "professionals" are often asked, either seriously or in jest, for retail buying help from friends and family. While there is obviously some overlap in skills and approach, it's a bit akin to asking your friend the Finance Director for help selecting a life insurance policy. Over at the consumerist, they've posted an article aimed at the consumer buyer, that has a lot a valid points for the professionals. The topic is buying on-line furniture, but just as it makes sense for a professional, it also makes sense for categories beyone furniture. Here are a few of the tips, and a link to the full article.

#7. Ask them about the shipping procedure and how long it takes for
the order to be processed.
# 12. Confirm everything. Hold them to their word, and WRITE DOWN THEIR
NAMES. Get their last name if possible.
#6. Ask them what the furniture is made of, and if it can be configured in
a number of different ways.
# 3. If they have a warehouse, ask for a tour. Take a look at the way they
warehouse employees act and handle the packages. What the retailer expects of
its employees is what they expect from their manufacturers.

Cheers,

David Rotor

Common sense lease advice

Terrence Belford writing in the Globe and Mail today has an article on negotiating commercial real estate leases. Here are a few nuggets of good advice for any supplier negotiations, not just negotiations with your landlord.

* Don't begin negotiations with a threat
* Understand your supply market and what options/substitutions are real
* Consider what the other side wants to get out of the negotiations
* What can you bring to the table that is more valuable to the other party than it costs for you to provide - and vice versus

The article concludes with a pitch from a real estate negotiating service "In seven years, we have never had a situation where we did not save a client and in some case those savings have been considerable."

If you're thinking about using a service to do negotiations you should think hard about that quote. Do you have the expertise and market experience to do as well as a firm that has been doing this for seven years? Consider that your internal staff haven't been held to the same standard of having to earn revenue from their expertise that a service provider is required to meet. On the other hand, also take a hard look at how they define savings and what strategic value your company expects to receive from the negotations that are not captured by the term "Savings".

Blackstone's Office Properties

In November I wrote about Blackstone's bid for EOP. It closed today at $39B. My advice still stands, they should take a hard look at their SG&A. I also recall something I had forgotten about back in November. When EOP was a client, a Vice President of Procurement had the last name "Borg" (I did a cursory check on the web-site and can't see if he's still there). It's a funny last name. For you Star Trek fans, ok, it's a little funny. For us purchasing types Borg means "B"uying "org"anization. Juvenile yes, but it still brings a smile to my face.

Cheers,

David Rotor

Limits of Sourcing - Part Deux. PI gets e-sourcing tool.

Back a couple of weeks ago I was thinking (and posting) about the limits of strategic sourcing. How small can a company's spend be and still benefit from sourcing? The challenge was to source for a client with less than $10M in SG&A across all categories.

The obvious constraint is the cost to source versus the benefit, and the relative market power generated by volume versus market knowledge. If one is trying to improve productivity deploying technology is an obvious solution. In this case, e-sourcing technology, "e-auctions" or "reverse auctions" is the technology of choice.

For those who are either not procurement types, or if you've been sitting in a three-bid cave for a few years here are some indications of the growth of e-sourcing technology.

* OGC, the UK government's "management board" is providing e-sourcing across many of their departments:

41% cost reduction in IT hardware costs.
http://www.theregister.co.uk/2006/06/08/public_sector_eauctions/

Here some background info on the OGC program.
http://www.ogc.gov.uk/documents/cp0025.pdf

* GSA, the US government's "management board" is also providing e-sourcing for the US government.

Fed-bid was awarded a five year contract to perform e-auction
http://www.fedbid.com/dictator/media/68/200701_general_overview.pdf

Here they announce they have conducted their 10,000th auction.
http://www.fedbid.com/news/46/ 10,000th reverse auction.

* Aberdeen, the analyst firm, has just released a report on advanced sourcing. Here's a quote "With an adoption rate within the Fortune 500 approaching 100%, eSourcing is a widely accepted business practice that can generate compelling benefits for its users."
http://www.aberdeen.com/c/report/research_briefs/RB_Advanced%20Sourcing_AB_3804.pdf

* ELP, European Leaders in Procurement, the magazine, explains why e-sourcing is good for suppliers.
http://blog.europeanleaders.net/procurement-blog/2006/10/4/why-e-sourcing-is-good-for-suppliers-part-i.html

* Here's a press release from my old boss. Minister Fortier bucks the trend of the UK government, the US government, and the vast majority of the Fortune 500 by making e-sourcing off-limits (ignoring the fact that the Canadian government has been conducting e-sourcing for close to ten years).
http://news.gc.ca/cfmx/view/en/index.jsp?articleid=237679

* Supply Chain Digest, the magazine, identifies e-sourcing as the #1 strategy for supply chain management in 2007
http://www.scdigest.com/assets/Reps/SCDigest_Top_10_Strategies_2007.pdf

Back to the $10M sourcing problem at hand. Let's assume for a minute that 30% of SG&A in 12 categories is addressable for sourcing - leaving $3M - and with a savings estimate of 10% that means the company could enjoy $300,000 in savings if sourcing can work on this small scale. What will it cost to use e-sourcing to attack those twelve categories?

For an industry that is fundamentally about pricing transparency to drive competition, it's remarkably difficult to answer this question. My own experience suggests that you can easily negotiate prices in the $2,000-$10,000 range for a single event. At the low end, this could work for the client ($24,000 cost against $300,000 benefit). At the high end, the benefits would appear in out-years. Alternatively, you could try and run it on one of the "supplier pay" models such as www.sorcity.com, though the low spend may not be attractive for the auction provider.

And finally, the approach I'm taking a hard look at. Tender System has released an open-source e-sourcing tool. I've just installed it on the Procurement Investor web site and will be configuring it over the next few days. I'm intending to also make it available to Procurement Investor readers in the near future.

Cheers,

David Rotor

Still fighting the talent war

(No I don't know anything about this comic - but it has great cover art for this article on the talent war)

The topic of recruiting and retaining procurement “talent” is a perennial favourite. Here are a bunch of articles:

Here - European Leader Net

Here - European Leader Net
Here - Procurement Central

Here - Supply Excellence

Here - A comment on Jason Corsello's blog, which is comprised of links to articles on procurement talent!

and

Here - Shared Services BPO

It was top of mind during a discussion this week about estimating strategic sourcing savings. In short, for the situation under discussion, we had two options to consider. The first was to provide training and technology support to a group of corporate buyers. The second was to engage “world-class” consultants to do the strategic sourcing for the client. Should we estimate a difference in savings between the two options? The consensus answer was that we should expect higher savings if we use the consultants. If you accept that the world-class consultants are more “talented” than a group of corporate buyers it appears that we were betting on talent.

In my case, that’s not true. I was betting on market knowledge.

A quick digression. I use the concept of “Market Power” to indicate the ability to negotiate favourable supplier contracts. The more market power you have the better the deal you can negotiate. Several things can contribute to increasing your market power. In my experience the most powerful are:

* Purchasing Volume - the most common approach (not the best, merely the most common) to strategic sourcing is to aggregate as much of the company’s spend as possible into a single contract
* Compliance – the ability to shift demand within your company to your preferred suppliers (and to credibly communicate this ability to your suppliers)
* Market Knowledge – the amount of information you have on current market conditions and suppliers

As I discussed, here, many organizations both over-estimate the degree to which volume will drive better prices and also often fail to understand what are the price/volume economics for a particular good or service.

Your suppliers' view of your compliance management ability (not your internal view) will strongly impact your market power.

In my experience, market knowledge is the strongest contributor to market power. Knowing what others have recently paid for a good or service, what the production capacity or utilization rates (goods, services) a supplier and their industry are experiencing and can support, what T&C’s impose non-standard costs on a supplier, etc, do more to allow great contractual terms to be negotiated than simply adding and delivering volume to a supplier.

Back to the discussion on relative savings rates. I was betting that the consultants would have more market knowledge by the simple matter of their firm frequently going to market for their clients as opposed to the corporate buyers who generally would only go to market every few years.

It would be fashionable, often true, and egalitarian to also say that consultants are rarely more talented than corporate employees. I don’t believe that, I think good consultancies often have very talented people on staff. What I do believe is that reasonably competent people who are provided with the right tools to build market power will out-perform highly talented people without those tools.

This raises some interesting conclusions. First, if you're going to bring in sourcing consultants, make sure the ones who show up have access to their firms recent market experience, and don't assume just because they are from a well-known sourcing consultancy that that is true.

Second, if you are fighting the “talent wars” you must also consider the environment in which that talent will be deployed. Can you offer talent an environment where they can promise and deliver on compliance commitments to suppliers? Can you provide them with the information they will need to remain market knowledgeable?

If the answer to either of those questions is “no”, “maybe”, or “we hope the talent will bring that to us”, you maybe showing up to a gun fight with a knife – talent will migrate to where they can be successful and remain talented.

Cheers,

David Rotor

Limits of Sourcing?

I've had a busy week. Apart from moving to a personally owned server, Procurement Investor, I've also been working on a large procurement outsourcing deal, the same one I wrote about here. And, I've been taking a look at some leads that are coming in from my post on looking to invest in procurement savings. I talked with some folks at Ariba on Monday, sharing some thoughts on delivering savings for our clients.

But the thing that's really caught my attention this week has been "how small is too small?". I've had the chance to look at some small companies this week, one that had only $5M in payables. It's not unusual to find a sourcing person who will claim that they routinely save 10+% on purchasing. We all, and I'll include myself here, always talk about how big a spend we've saved against. No one brags about how small a spend their expertise is effective against.

I'm intriqued, can strategic sourcing work for a $100M revenue company? How about a $10M revenue company?

If I find out, I'll let you know.

Cheers,

David Rotor

Back to business

This past fall I’ve been working to raise a fund to directly invest in improving procurement operations for companies. Over the winter holidays I was informed that the fund will be closing in two tranches, mid-January and March.

The fund is authorized to make investments that will generate financial savings for client companies. My “tag line” for this blog is that “There are few investments a company can make that rival the returns from investing in their own supply chain.” The expected returns from this fund are representative of that thinking. We expect to invest $2-$3 million with a goal of generating $20-$30 million in savings from expenditures of $200-$300 million. Here's a two-page summary of the offer.

Investments from this fund will primarily be used to pay for consulting fees for strategic sourcing – we intend to hire world-class sourcing firms to do the sourcing on these engagements. In order to deploy the funds we’re looking for client companies who are want a risk-free way to lower their cost of purchased goods and services. As this fund progresses I’ll provide, on a “no-names” basis, details of some of the company opportunities we look at, and any investments and savings we make.

And the shameless sales pitch … you can contact me through my blog email, davidrotor@procurementinvestor.com if you know of any companies that might be interested.

Cheers,

David Rotor

Happy Holiday, see you in 2007

I'm going to take next week off for time with friends and family. See you in 2007. And as a little holiday treat. Here's a link , from Tim Minahan, to the value of sourcing. It seems that e-sourcing will save you 80% on the cost of the 12 days of Xmas.

Cheers,

David Rotor

Engaging internal clients

In Buying Market Share I touched on the idea of measuring procurement department effectiveness through the share a category manager has earned (compliance) of the internal market to purchase their good or service as well as the share of an internal client's overall spend that the procurement department has earned. To improve, the procurement department needs to better meet the needs of its market. The simplest way to do this is to understand the market, whether it is for a single category across the organization, or the multi-category spend of an internal business unit.

I created an approach, Client Engagement, stolen from borrowing on skills and techniques from the sales world that allows the procurement team to engage with their clients in order to better understand their requirements and drive improved market share. For readers with experience in strategic sourcing, this level of engaging with a client is similar to what is done during a category sourcing exercise, but moves from being a event driven exercise to embedding it as a recurring procurement department business process. Here’s a graphic that provides a summary of the Client Engagement process.

Outsourcing business cases

I'm spending some time thinking through an outsourcing business case. The client has an expectation that the proposal will fit into their existing budget for the function (procurement and payables), independent legacy systems will be retired and new functionality will be added with the introduction of an integrated system, and ideally costs will be lowered. On the other side the service provider understandably wants to do all that, and turn a reasonable profit. So far, so good.
The difficulty is that the service provider's business case is turning up at about 150% of the existing budget. The work can be pretty quickly broken down into three areas to explore, plus one more:

The existing budget

This is a classic outsourcing issue, service provider's routinely strive to identify expand what's included in the existing budget, and client's routinely try to limit what's included. Direct costs are reasonably straight forward to nail down, allocated indirect costs such as contributions for space, corporate technology, support functions such as HR and accounting, are the usual areas that cause conflicts, and can determine whether a deal proceeds or fails.

The service provider's cost model

This tends to be a great area for "pursuit teams" (sales) to delve into in great depth. Most large outsourcing service providers have built wonderfully complex cost models to help them capture what it will cost to service an account. Routinely, I'll find that there is a bit of a fortress mentally around the cost model and it can often be as difficult to get the team to disclose line item details from the cost model as it is to get the client to share detailed budget information.

The first area to explore is whether the costs are market based or internally derived - don't accept the assertion from the cost team that they are market based, go and test the market yourself.

The second area to test is whether the internal costs have been inflated with an internal mark-up, again the cost team will routinely suggest they do not mark up costs, prove it for yourself.

The third area to examine are the overheads, are there too many people loaded onto the deal, are there costs loaded such as standard space or technology charges for people that have already had those costs modelled as direct costs for the contract, etc.

Going back over the last decade I've seen numerous cases where the cost team has contributed to proposals being, literally hundreds of millions of dollars over the market.

The service provider's pricing model

There is often little a pursuit team can do about the margin the company wants to earn from a contract, you win or lose in the market and margins will be adjusted to reflect that reality. What the pursuit team can do is vigorously target the "risk" model that can increase or decrease the margin calculation. Most (likely all) the major outsourcing service providers have developed formal risk management frameworks in their internal deal approval process. The one for the deal I'm looking at now runs about 200 questions, such as: Is the proposed deal a "factory" deal or a "fortress" deal? “Factory” means that it can be managed in a shared service facility, “fortress” means it is a unique offering that is customized for the client. Fortress deals have, in the model, a higher risk factor, and the discount rate applied to the price model is increased. Each of the 200 or so questions have similar impact on the discount rate. The pursuit teams need to spend time understanding the risk model, but often it is viewed as an administrative exercise, and the pursuit team doesn't ever really understand how the model will impact the success or failure of their proposal.

Strategic Sourcing

Outsourcing teams should also consider lowering the cost of goods and services in the function they are taking over by using strategic sourcing. I won't get into it in this post, but it's often possible to lower those costs by 10% or more, enough that many deals will live or die on the application of sourcing to the deal. Spending time to have an expenditure analysis performed to determine if there is an opportunity is well worth considering.

Cheers,

David Rotor

Equity Office Properties acquired by Blackstone. A small procurement investment would make sense.

Today Blackstone announced they were acquiring EOP in a record setting leveraged buy-out worth $36B ($20B to shareholders and $16B in acquired debt). This story caught my eye as a few years back an e-marketplace I worked for served EOP and we also worked for a few months to convince their new VP Procurement to hire us for procurement services work. On the other side of the transaction a former client is now a Managing Director at Blackstone. I think this transaction can help illustrate my statement that few investments can rival procurement for generating returns for companies.

The sources and analysis appear below.

EOP has approximately $850M in sourceable spend, that is the cost purchasing of goods and services that typically can be negotiated. Based on my recall of discussions at EOP and similar REITs I estimate that approximately 50% of the spend could be addressed by strategic sourcing - $425M. Strategic sourcing in this industry typically yields savings, net of $4M in sourcing costs, of 8% or $34M in annual savings.

So apart from generating an incremental $34M to the bottom line, how else can we describe the impact an incremental investment of $4M in Blackstone's $36B acquisition of EOP achieve?

Current

• Earnings per common share of Operating Income: $2.27
• Earning per comon share of Net Income available to common shareholders: $0.02

After a $4M procurement investment

• Earnings per common share of Operating Income: $2.35 (an incremental $0.07 per share)
  
• Earning per common share of Net Income available to common shareholders: $0.08 (an icremental $0.06 per share)
  

So, the question is whether Blackstone will make room in a $36B budget for a $4M investment that quadruples the earnings per common share of net income available to common shareholders.

Source: EOP Annual Report 2005

• Revenue: $3.0B
• Operating Expenses: $2.1B
• Operating Income: $0.9B
• Net Income available to common shareholders: $8.1M
• Weighted Average Common Shares Outstanding: 403,147,751

Source: Procurement Investor Analysis

• Earnings per common share of Operating Income: $2.27
• Earning per comon share of Net Income available to common shareholders: $0.02
• Sourceable Spend: $849M (Repairs & Maintenance $341M, Property operating $442M, Corporate and general administrative $67M)
• Addressable spend: $425M
• Cost estimate to source $425M in addressable spend: $4M