Adopting Strategic Procurement principles can help fund the National Living Wage

The surprise budget announcement of the National Living Wage will see workers aged over 25 in the UK paid a minimum of £7.20 an hour from April 2016, rising to £9 by 2020.

This legislative change will have a huge effect on many sectors, including retail which employs over 20% of those on the current minimum wage. To put the cost into some context, a typical retailer employing 25,000 people on a rate of £7 would expect to incur an additional £100m a year bill by 2020.

Although the direct increase in costs organisations will see are self-evident, and have been heavily reported on, less attention has been given to the additional cost inflation retailers will see through their supply chains and specifically from their indirect costs, including contracts such as catering, cleaning, logistics and warehousing.

Back to the example of our retailer, indirects can account for a not insignificant 10-25% of all expenditure but, whilst clearly a major cost line, does not in our experience receive a suitable level of strategic focus and attention.

The task for all organisations will be how to respond to and mitigate such substantial future cost challenges without passing 100% of the expense on to customers. As we see it there are two approaches that can be taken.

The tactical approach: Focuses on staff reduction or on reducing average age of the workforce. Some have also discussed the possibility of taking out costs by reducing perks such as staff discounts.

The strategic approach: Focuses on the need for greater productivity in light of the wider structural changes of which the National Living Wage is a part. Relating this back to retail once again the sector has undergone fundamental change and disruption in the new digital age, and successful retailers continue to adapt to rapidly changing consumer demands on their businesses.

Forward thinking organisations are meeting these challenges by engaging with suppliers, investing in systems, and getting the basics right with a co-ordinated strategy across the supply chain, customer facing channels as well as reviewing their underlying operating models.

Value released from effective indirect procurement can enable and accelerate the strategic approach with focus on this all too often untapped value pool. 

In the short term significant savings can be found without some of the complexity and trade-offs often required to find efficiencies in other areas.

In the longer term embedding strategic spend management principles into every day thinking forms the bedrock for swifter adaptation to wider structural changes and the mitigation of both the direct and indirect costs that will entail.

In todays every changing world and challenging environment there is no set formula for whom will win or lose. What is clear though is that successful organisations will not simply rely on a short term tactical approaches but have a clear forward thinking strategy that recognises that traditional approaches and business models may no longer work.

The introduction of the National Living Wage should only serve as an opportunity to explore more strategic solutions and converging on untapped resources allows organisations to release huge value in order to drive or accelerate transformation programmes, effectively using strategic procurement as a business enabler.

Procurement’s challenge – how to become a career of choice

Over the next few weeks undergraduates across the country will be sitting their finals and setting themselves up for the next stage of their lives with careers in differing fields. A few may become Procurement professionals but it is doubtful that many would have considered it as their career of choice. Indeed it seems that the old mantra for Procurement still holds true – it is very much something that people fall in to.

Clearly there is more to be done to market ourselves to students across the country. After all although Procurement may not have quite the same allure to it as Investment Banking, salaries are on par with functions such as finance and HR and the level of exposure possible to young graduates is well beyond the norm, helped by the quick progression of procurement up the value chain.

CEO’s expect far more of procurement than they did 5 years ago. They have challenges on their agenda such as raw material price volatility, pressure on profits, increasing risks and a need to innovate and become more sustainable. Procurement are well placed to lead on these challenges and CPO’s are being asked to generate cash whilst minimizing supply chain risk and leapfrogging competition.

As a result a fresh faced procurement professional can expect to be thrown in at the deep end, with high levels of responsibility and expectation as well as the pathway for progression that such experience affords.

There are downsides to this increased level of exposure. Procurement is often in the press as an object of derision concerning issues such as payment terms, supplier treatment, working conditions and general money wasting. We have to be careful here. Procurement can’t get into a position where it takes the rap for things when they go wrong but isn’t considered as a strategically important internal function – that most definitely wouldn’t be appealing!

So what can Procurement do to move from a career choice of the desperately undecided to one which is a wilful choice?  I think the answer is twofold.

Firstly, and most importantly, Procurement has to build on the momentum gained over the last few years and truly progress from a tactical function to one with a clear position in the Boardroom and beyond that offer a true path through from entry level graduate to CEO.

There is definitely not the recognition currently that CPO’s can progress on to the top role and I think it is primarily because procurement is seen as being far too risk adverse. “Taking a risk, having a punt, having a go”, virtues extolled by David Cameron on his recent campaign trail, may seem slightly tacky, but are necessary for anyone wanting to make the step up to the top job. Procurement in general should adopt more of this attitude. Hiding behind process and what has gone before is limiting the perception of what Procurement can achieve.

Inwardly then Procurement still has quite a lot of headroom for improvement however we are on the right trajectory. The second challenge comes in selling ourselves to the vast swathes of students who are currently taking their skills elsewhere.

There’s no easy answer here but the fact there are only a handful of bachelor’s or master’s degrees available to students in the UK can’t be helping matters. It is CIPS long stated aim to licence Procurement and in the long term, if this aim is realised, I believe that will help legitimise the profession and act as a platform for change.

The time frame for such licencing is hazy though and implementing it also has its complications. In the meantime we should look to enforce the view that procurement is an integral, strategic part solving the wide challenges a business may face.

The view that procurement is simply just buying does not marry up with the function in the 21^st century. The tests a buyer faces are broad and complex. From ethical dilemmas through to commercial appraisals, stakeholder conflicts and game theory the basis of being a good buyer will set you in good stead for a comprehensive range of senior roles – this is the message we need to be selling.

Will the transparency of payment practices lead to a change in corporate behaviour?

Would the behaviours of big business change if they were forced to report on how they paid their suppliers? Well we don’t have very long to find out as in 2016 new regulation comes into force which will require all quoted companies and LLP’s to do exactly that.

Over the last year there have been a number of high profile cases where big business has been accused of taking up the role of classroom bully. Mondelez has been taken to task, as well as Mars, Kellogg, Heinz, InBev and Tesco amongst others and their favourite practices does seem to be the extending of payment terms. Pre-crash 2008 there doesn’t seem to have been too much reporting on the subject and it would appear that while pushing out terms was initially used to ensure continued existence during that rocky period it has since turned into a valuable cash cow at a time of limited growth and diminishing profits. There is also a push to follow the pack, driven by the demands of shareholders and analysts. These businesses are vastly competitive and cannot afford to allow rivals to steal a march; especially one as tangible as this when pushing out terms can offer potentially tens or hundreds of millions of pounds to an organisations cash flow.

I am pretty sure that part of the reason organisations are able to do this is that they are mainly geared up adapt and react to the demands of their consumer. As it stands there is little information that is presented to the consumer that allows them to make an informed choice about whether they buy based on a firm’s payment processes, and as such not much that stops them in following this route.

I can however see this becoming more and more of a customer issue. We have already seen over the last year in the UK that Starbucks has been forced to change tact on corporation tax, based largely on the backlash from consumers. No one would have wanted press like that.

Customers put a large amount of faith in the organisations they choose to buy from and expect a degree of business integrity, ethical and social standards that they may not have considered 10 or 15 years ago. When a company is not deemed to have hit these standards in the eyes of the customer they don’t react well (recent examples such as “horse gate” spring to mind) and given the rise of social media and the transparency of information what may have been one person’s gripe in years gone by may now be a topic of interest to the masses.

This legislation change may well push the payment processes of organisations into the sphere of interest of the consumer. New information will be readily available to an attentive press corps to whom it should be no trouble to report on industry comparisons and the best / worst practices of big business. It is easy to see how one well-placed article might spark curiosity in the subject.

So will behaviours change? Well I have discussed before how focus on such a singular element of the working capital equation as payment terms is probably not effective in the short or long term and hopefully businesses start to agree. I would like to think that this legislation will act as an impetus to change as firms begin to see the negative PR risk from simply extending terms.

Procurement can take a lead in this area, helping to improve overall working capital through a collaborative supplier management approach. Business relationships need not be so one sided and the negative risks associated with them being so will come back to bite in this new world of transparency.

Procurement and Finance: In partnership

Last time I wrote about the journey of the Procurement function in its maturity towards strategic importance and a major part of this is the developing relationship between Procurement and Finance. Continual wrangling over savings and methods instead of collaboration does little to benefit the organisation as a whole, particularly when in reality there is enormous alignment between the two functions in terms of vision and goals.

So how can Procurement and Finance work together to release organisation wide value?

Agreement on reporting standards

So often the bugbear of both functions is the differing meaning behind the term “savings”. Finance hear the term and expect to see a reduction to the bottom line and Procurement professionals often see them as simply price reductions. Not every price reduction is reflected on the income statement and as such doubt arises as to Procurement’s cost savings claims. Mutual agreement of standards warrants against unwanted surprises and generally makes the reporting more believable. The two areas can’t operate together in an effective and collaborative manner unless this point is addressed. An underlying trust needs to be created.

KPI Alignment

Finance and Procurement have developed at different rates and have, to a certain extent, only really come together over the last five years or so. As a result they have differing and occasionally contradictory KPI’s and often operate in siloes. If the two are truly to operate together it is important that the KPI’s align and move beyond the historical view on just savings. Performance should be measured on performance to budgets, supplier performance and compliance to contracts as well as just cost savings, to name but a few.

Use Technology

Modern technology can provide a platform by which the two teams can set common objectives on savings and track and monitor those savings. The transparency afforded by technology ensures that there is a single version of the truth which enables finance to forecast and book savings in an accurate and timely manner.

Budgeting and Planning

It is up to Finance to drive the budgeting process but Procurement involvement is the key in ensuring that the savings they have identified are implemented and finds their way to the bottom line. Procurement involvement doesn’t just have to be historically focused though. As a link between a hosts of business functions they can work with Finance to offer insight into potential savings from existing and future cost reduction programs, helping to set realistic budget and planning targets for the coming period.

Education, Training and Understanding

The majority of Procurement professionals are not Finance professionals but that doesn’t mean they shouldn’t be provided with at least a basic understanding of some of the metrics used by their Finance counterparts. Terms like return on invested capital (ROIC), days payables outstanding (DPOs) and days sales outstanding (DSOs) are vitally important to Finance teams and, in aligning KPI’s and goals, should also mean something to Procurement. Wider knowledge of how to budget and plan, report on variances, actuals and forecasts should be part of the day to day life of the procurement professional. Even if they aren’t engaged fully with their internal Finance team the chances are when dealing with suppliers they are meeting with their Finance teams and being able to read a balance sheet in terms of payables can help build internal and external relationships.

There is benefit in Finance becoming more understanding of the ways, means, goals and objectives of Procurement as well…it’s not just about savings. All in all a more empathetic approach all round to each other’s roles will help build links.

Supplier Performance Management

Finance may be interested in things that Procurement aren’t necessarily such as the overall supplier financial health, seasonality and the balance of trade and as such there is value in approaching supplier management collaboratively. Finance may also be able to support Procurement in exploring flexibility in the relationship by offering early settlement discounts etc. which may not have previously been considered as a lever to pull on.

There are clear issues to overcome in aligning the two functions and a good degree of difficulty given the years they have spent apart but in working together Procurement and Finance can offer value to a business greater than the sum of their parts.

Ozzy and Sharon Osbourne as a case study for Procurement and Finance

I imagine that being a celebrity couple comes with its difficulties. Often forced together as it seems convenient and faced with the constant enticement from tinsel town, many treat marriage as a temporary arrangement between film roles.  There are however still a few examples of famous couples whose love and commitment have endured through tempestuous and tumultuous times and the Osbournes are a great example.

In many ways Procurement and Finance are like a celebrity couple (bear with me) and of all the celebrity couples I could think of probably most like the Osbournes.

Why?

Well first of all why exactly are they like a celebrity couple? Procurement has at various times had flings with the CEO, CFO, CAO, COO and CIO, more than enough to keep the tabloids happy. Procurement and Finance were put together primarily because they both had a shared interest in numbers and savings but it wasn’t exactly a bond considered binding – more of a mutual hobby than anything else – and a marriage of “convenience”.

Differences in the way both sides approached the hobby caused ructions. Procurement would talk about millions of savings delivered, of cost reduction, negotiation and low cost country sourcing. Finance would talk about the bottom line, reporting, inventory management and credit goals. So there was a common goal but a different approach to getting there. I’m going to try and relate this back to golf...

Procurement has grown up and has become more strategic and mellowed. Whereas in years gone by it would walked onto the course and swung away it’s now more interested in improving its handicap and sees merit in some of the things Finance was doing before.  It submits accurate scorecards for example and plans out its approach in advance.

As the two have become more aligned the two parties have grown to accept each other, the value that they can offer as well as their foibles. Procurement may have previously wandered from department to department but has now found its true home. The relationship has value and is beginning to endure.

So onto the Osbournes. There aren’t many celebrity couples that last and particularly not many that have been so (publically) stormy. It’s a relationship that has survived because together the two of them are undoubtedly stronger as a pair, share a common vision and goal, have both come to appreciate each other’s values and faults and have both mellowed with age.

As Procurement moves up the value chain and becomes more strategic it has a natural ally in Finance. Over the next few weeks I will be writing about how the two can better collaborate and integrate for the benefit of a wider organisation.

Procurement 2.0? Procurement is in beta

It is surprisingly hard to find a concrete definition of what is meant by “Procurement 2.0” but, given that it takes its name from the rise of Web 2.0, we can make some assumptions as to what was meant by the term.

Back in 2008 A.T Kearney’s “Assessment of Excellence in Procurement” Study, highlighted the growth in Web 2.0 based collaboration solution adoption and the trend has continued ever since. The rise of social networking, blogging, social tagging etc. has changed and will continue to change the way businesses and procurement carries out their day to day operations. This is an area I have covered in a previous blog post and is currently seeing an accelerated rate of development. Note for example the move towards more tightly linked P2P systems and the growth of cloud based offerings from the likes of Ariba and Coupa.

There is a real danger here though that Procurement 2.0 is seen as a technological, process and data driven nadir when actually in reality it should be a lot broader than that. Whilst no doubt the advancement and adoption of new web 2.0 solutions and the development of cloud based e-procurement solutions have a massive role to play, there has to be an appetite to look beyond the data / process and to consider advances in, amongst other things; people, technology, risk management, benefits realisation.

Procurement is, and will always be, first and foremost a people business. A function that rests solely on process will have fruitless relationships with their supply chain and no hope of developing their position as the customer of choice. Moreover a core skill of a procurement manager involves the ability to handle internal customers which involves subtle engagement and time. I would have thought it is exceptionally tempting to run functions such as procurement as lean as possible but, in a slight paradox, it would seem that as companies become more technologically driven and layered in their approach good people matter more than ever.  If these people can’t be recruited directly then consider working with a 3^rd party who is able to bring in such expertise…process and technology can only go so far.

Procurement is in a state of change however I’m not sure the 2.0 label is one that sits well. Technological and data driven change will continue at a pace for the foreseeable future but 2.0 mustn’t be seen as a surrogate offering to traditional procurement. A good, flexible process harnessed with talented people should be the base from which to deliver a true strategic sourcing solution.

PwC recently released an excellent piece related to all things digital called “the world is in beta” (https://www.youtube.com/watch?v=Fh3SSCK2rtE) and I think the tagline is one that fits here. Procurement isn’t moving towards 2.0, it is instead in beta.

The development of cryptocurrencies

Over the last few years it has been hard to escape news of the development of cryptocurrencies such as Bitcoin and Litecoin. Cryptocurrencies can be seen as one of the most disruptive trends in the world of payments and, according to Goldman Sachs at least, will help shape the future of finance.

What is a cryptocurrency? Cryptocurrencies (or digital currencies as they are also known) are essentially secured peer to peer currency and transaction networks but, unlike a traditional system, are decentralised. Their creation is not controlled by central banks and this allows direct payment to be made between payer and payee without an intermediary bank. “Money”, both physical and electronic, has to serve three main purposes to society.

• A store of value – The ability to buy goods or services with the currency at a future date
• A medium of exchange – with which to make payment
• A unit of account – to measure the value of an item for sale

In general, cryptocurrencies are designed to have a limited supply in order to keep the currency scarce and valuable but it is debatable as to the extent to which they currently satisfy all three of these points.  What isn’t in doubt though is that they have become more popular over recent years and with further proliferation of platforms and coverage their rise will probably endure. This is evidenced by the fact that Bitcoin recently took centre stage at Sibos, a traditional banking conference, and prominent articles on the subject from institutions such as the Bank of England.

So what are they benefits of using cryptocurrencies as opposed to traditional forms of money?

Well the obvious one would be low transaction fees. The money has to be “mined”, which does come with a fee, but the cost is still small in comparison with sending money through the banking system, especially when it involves sending money overseas. Tied to this cryptocurrencies also come with an element of freedom in that they allow you to send and receive money anywhere in the world at any time without the usual limitations (bank holidays for example).

They are also secure, hiding any personal information which protects the vendor and allows for an element of control not generally seen with traditional currencies. No extra fees can be charged for example without agreement with the consumer first. Taking this a step further it is possible to assign rules to the transaction such as the agreement of payment terms through a supply chain or the ability to spend money in the local area, which allow for a sphere of control not currently easily achieved. 

There are of course disadvantages to using cryptocurrencies as well, the main one being there is still a lack of awareness of them and how they may be used. Some businesses are adopting them (63,000 according to Informilo) but the list is still relatively small and it will take some time before adoption is widespread. Cryptocurrencies are also more inherently volatile than traditional currencies, which doesn’t help with their standing as either a “unit of account” or as a “store of value”. Over time this should settle down but price rises and falls of 20% in a day are not unheard of.

Cryptocurrencies are still developing and with that will come a sense of legitimacy. Previous exploitation, in the early days, from drug dealers and money launderers disguise the fact that any financial system can be abused. The fact that they are now being adopted to manage B2B transactions, albeit on a small scale, should be a guiding stick towards future acceptance. There are hurdles to overcome, such as establishing rules and regulations but the ability to transact openly and without burdensome cost implications has massive advantages and procurement teams would be wise to understand them before they miss the boat.

Adopting and applying a sustainable procurement approach

As we have already established there are substantial commercial benefits to be had from implementing a sustainable procurement approach as opposed to simply paying it lip service. How though would an organisation go about adopting and embedding sustainability into their day to day operations?

I think there are six simple steps a procurement organisation can follow to ensure sustainable sourcing becomes a core element of the purchasing process.

·         People

As with all change programs it is imperative that everyone’s role is totally clear and preferably that there is a singular point of contact, a “Sustainable Procurement Champion” if you will, who has the support and buy in from the senior management team and is on point to provide updates of progress, both internally and externally. Given the complexity associated with the topic Procurement will also require the appropriate level of training in sustainable procurement best practices and, to help steer everything in the right direction, be provided with clear goals and objectives for which they hold ultimate accountability.

·         A business case

Clear objectives as well as the stakeholder community and overall benefits need to be documented to provide a framework to the overall program. Ensuring that everyone is bought in to the overall goals of the project will give Procurement a mandate to help develop the overall policy, strategy, action plans and any projects that will ultimately fall under the sustainable procurement umbrella.

·         Policy, Strategy and Communication

Any objectives agreed should be embedded within every procurement strategy and policy developed by an organisation. This overall policy must be mandated by senior stakeholders and ultimately must be cascaded throughout the organisation and to the supply chain. The sustainable policy, which must interlink with the overall strategic plan, should ideally be endorsed by a 3^rd party and be reviewed on a regular basis to ensure that it is a) relevant and b) achievable.

·         Process

Everyone’s most exciting topic but it is imperative that processes are developed to ensure that sustainability is considered at all times when sourcing goods or services. As I mentioned previously the topic of sustainability is a large one but as a few examples such processes may consider the identification and reduction of supply chain risk, the material make up of products or whether a supplier can indeed support the contract for its life.

·         Suppliers

It is vital that the supply chain, through a mixture of supplier performance and relationship management, are bought in to the overall approach. Engaging them may result in sustainability targets being set for the provision of goods or services (carbon reduction, supply chain risk management, accreditation etc.) and these targets being managed through a series of KPI’s. The supply chain can also be a vital source of innovation in this area which can be used to accelerate the delivery of your own objectives or indeed other suppliers if a collaborative supplier management model is in place.

·         Benefits Realisation

At the start of the process it was important to set out a business case for sustainable procurement. It is just as important that there are various touch points at which you look to validate the benefits that have been achieved as well as identify and implement any other changes which may have a positive effect on sustainable procurement. This may involve reporting against the original goals or metrics, benchmarking against other organisations or identifying actions from feedback to improve the process.

Sustainable procurement isn’t easy and takes an enormous amount of time and effort to achieve but by identifying clear goals and objectives and by ensuring there is a high level of internal and external engagement there are extensive advantages to be had.

The benefits of “common sense” sustainable sourcing

DEFRA defines sustainable procurement as "a process whereby organisations meet their needs for goods, services, works and utilities in a way that achieves value for money on a whole life basis in terms of generating benefits not only to the organisation, but also to society and the economy, whilst minimising damage to the environment".

Previous scepticism over the benefits of a sustainable sourcing has given way over recent years to an understanding and appreciation of the value procurement teams can add by adopting such an approach. I don’t always think the word “sustainability” helps in situations like this, being a relatively divisive term which is greeted by some with rolled eyes. In many ways however sustainable sourcing is the “common sense” approach to strategic purchasing.

Here is a sample of the wide spectrum of topics that are usually bracketed under the umbrella of sustainable sourcing:

• Overall security of supply
• Managing carbon and water footprints
• Efficient use of resources
• Right shoring and local sourcing programmes
• Ensuring socio-economic standards
•  Supporting the development of labour standards and human rights

The question is how, in encouraging procurement involvement in this space, organisations will begin to realise long term benefits? I think in addressing each of these topics it is possible to split the potential benefits into three distinct areas.

• Cost savings (where else to start!)
• Increased efficiency of procurement
• Optimised resource use (e.g. energy, water, chemicals)
• Lower price of raw materials
• Reduced logistics costs
• Increased savings through collaboration in supplier performance and relationship management
• Excise appropriate tax breaks e.g. capital and enhanced capital allowances
• Revenue protection and generation
• Increase the overall security and quality of the supply chain.
• Ensure continued product innovation and development – continuous improvement approach
• Reputational management is something that is going to become more important as supply chains become more transparent and the consumer more engaged.
• Potentially further market access. Licenses to operate may be based on certain conditions being understood or met.
• Access to funding and other revenue streams from government, donors, carbon credits etc. from adoption.
• Risk management
• Reduced operational risk
• Reduced foreign exchange risk

Adopting the common sense approach, and as such embracing sustainable procurement, is a way to further procurement’s value to an organisation whilst reducing risk and waste and improving efficiency and the total cost base. Only a short blog this week but hopefully next time I can go into a bit more depth when considering how to adopt a sustainable sourcing model.

Mandatory carbon reporting

A slight change in tact this week for this blog away from technology to a topic I want to try and get more immersed in during the course of 2015, that of sustainability. This week I’d like to briefly explore mandatory carbon reporting and the implications and opportunities for procurement.

In October 2013 the UK Government announced that quoted companies would be required to report their annual greenhouse gas (GHG) emissions in their directors’ report. GHG emissions are categorised into three “scopes” by the GHG Protocol. Scope 1 and 2 cover direct emissions sources such as the electricity that a company purchases or fuel that is used in company vehicles. Scope 3 is more in depth and covers all indirect emissions due to the activity of an organisation.

The UK Government have provided a quick helpful summary guide as to what is included in each “scope” level:

Scope 1	Scope 2	Scope 3
Fuel combustion Company vehicles Fugitive emissions	Purchased electricity, heat and steam	Purchased goods and services Business travel Employee commuting Waste disposal Use of sold products Transportation and distribution (up- and downstream) Investments Leased assets and franchises

It is worth noting at this stage that the term ‘procurement emissions’ or ‘supply chain procurement’ is widely used as a shorthand for elements of scope 3 emissions and it is here that I think procurement can probably get most involved and add most value.

Although scope 3 emission reporting is not yet a mandatory requirement (and there is no expectation that it will be for some time) some firms are reporting on them and I expect more will continue to do so for CSR purposes. It is fair to say that at this stage the private sector is behind the public sector but the expectation is that the government will undertake a review and decide in 2016 whether to extend the regulations to all large companies, potentially adding 24,000 organisations to the already c. 1,100 that have to mandatorily report both on both scope 1 and scope 2.

So how can procurement become more occupied in scope 3 reporting and where can they add value? 

Let’s consider some of the activities that would be involved:

1.       Assess the supply chain for emission hotspots

2.       Identify resources and energy risks

3.       Identify energy efficiency and cost reduction opportunities in the supply chain

4.       Engage with suppliers and assist them to implement sustainability initiatives

5.       Purchase more energy efficient products

6.       Help companies reduce emissions from business travel and employee commuting

7.       Help identify leaders and laggards in their supply chains

At present many organisations that are attempting to report to scope 3 are doing so without procurement involvement and, as you can see from the list, the activities involved would suggest that integration with procurement departments would uncover huge benefits.

I would expect a move towards a change in procurement strategy in the coming years to reflect the changing focus in the market, both in terms of legislation and general mood towards sustainability. 

Price will continue to be important, however on-going energy costs including carbon credits, as well as the impact of carbon on CSR and reputational risk, are becoming more and more intertwined in procurement decision making.

The steps involved in running a successful eAuctions

 Last week I went through the various forms of eAuctions available to the procurement professional; from the traditional reverse English through to Japanese, Dutch and Multi Stage variations.

Choosing the most appropriate auction for your commodity or category area will help ensure a successful outcome but when it comes to actually setting up an event and seeing it through to completion there are a few simple steps that I would suggest are followed.

1.       In the beginning

·         Make sure there is a single point of contact responsible for the auction. Suppliers don’t like having to deal with a range of different individuals and it ensures that the communication channels are clear. This single point of contact also needs to be reciprocated on the supplier side

·         Choose the right auction type (if it’s applicable at all)

·         Communicate a process plan for the auction both internally and externally

·         Make sure that the specifications for the products or services being auctioned are as clear as possible and there is no room for ambiguity

·         Decide on the selection criteria as to who is going to progress through to the eAuction – assuming that RFI etc. has been run beforehand.

2.      Design

·         Decide award criteria. Does the lowest bidder win in all circumstances? Make it totally clear that the lowest price may not always win.

·         Plan and agree timescales for live auction both with your internal stakeholders and the suppliers.

·         Design and build the auction as well as the bidding strategy including the rules, extensions and award criteria.

·         Ensure that all suppliers are operating on a level playing field (eAuctions are transparent) by standardising the communication and training you provide.

·         Plan in the eAuction to run at a time that will suit you but also allows everyone to fully participate. This may involve considerations of multiple time zones for example or setting an auction to close past standard working hours to speed everyone up.

3.      Communication and Training

·         Make sure that the Supplier is fully briefed on the eAuction process, including both the format of the event and the timings. Timing will include both the actual event and the expected steps post event

·         Train, train and train again. There is nothing more frustrating than having to halt an event because a supplier makes a mistake or doesn’t know what to do. Suitable training ensures that there are no excuses on the day of the event.

·         Run a test eAuction as part of the final training consisting of all the same rules, extensions etc. This gives suppliers an opportunity to familiarise themselves with the format and also gives you a chance to make any last minute changes should they be required.

4.      The Live eAuction

·         Log in in advance to make the eAuction available to all participants and check they are logged in prior to the actual event.

·         Provide contact details for a technical helpline for suppliers during the live event and arrange for a support team to enter buds on the supplier’s behalf on account of any technological issues.

·         Only send out messages that have been agreed and vetted prior to the event

·         Get your stakeholders involved! eAuctions can be good things to watch and drum up some excitement

·         Don’t be afraid to make changes to the event as it happens however ensure that the possibility of those changes was communicated in advance.

5.      Post eAuction

·         The responses should be assessed against the initial criteria agreed with the stakeholder team and the winner selected accordingly.

·         Conduct your post auction negotiation if it is applicable and was specified as a possibility at the outset.

·         Inform participant of results and provide them feedback about their performance in the sourcing process and where they missed out – it can’t hurt and they will want to hear it.

·         Request feedback about the sourcing process from your supplies and your stakeholder team. Anything that can be learned for an improved future performance is useful.

6.      Watch Outs

·         Do not allow suppliers to increase their bids (unless it’s a forward eAuction obviously) and be quite explicit in the rules about this. Suppliers can ‘fish’ by lowering their bids to see where the winning position is and then request that their bids are raised again.

·         Do not allow suppliers to participate who have not been through any prior training or the prior evaluation process – everyone should be on a level playing field at an eAuction

·         It goes without saying really but don’t bid yourself!

·         You may have suppliers in the event that have no intention of honouring their bid and only wish to drive down the price for other participants. You need to be conscious of this before the eAuction but be wary…although a better result may be obtained it may not be sustainable and may also demotivate others in the event and derail any supplier – buyer trust.

·         If you state that the lowest price or the highest score in a multi variable auction will win, do not then pick a different supplier to win the auction if this was not achieved by that supplier.

·         In a multi variable auction, display the position of suppliers taking into account all the criteria, and don’t display price positions only

·         Don’t select an eAuction as the most appropriate route for the sake of it. Consider whether it is appropriate and if so the form of the event.

Turning Japanese…a view beyond the English eAuction

As I briefly touched on last week eAuction technology has moved on somewhat in recent years and is now utilised to procure a whole variety of goods and services outside of the stereotypical, and obligatory, stationary re-tender. Auctions themselves are nothing new; the position of Emperor of Rome was auctioned off in 193 AD, but these days there are so many different parameters available to the procurement professional who is able, if needs be, to run a whole array of multi-attributable and variable eAuctions.

Many procurement professionals however still remain unenlightened to the vast toolkit at their disposal and are merely preconditioned into persisting with the classic “English reverse” eAuction. This standard approach is appropriate in a wide range of circumstances but may not always be so. I would like to briefly describe the other forms of eAuctions available, their respective mechanisms, strengths and weaknesses.

1.         Forward English Auction

·           Mechanism

Anyone who has attended a property auction or is familiar with eBay will be familiar with the way this works. Essentially bidding starts at a low price and rises as participants place progressively higher bids. This process continues until either the period allowed for the auction of this item is closed or until no higher bids are received. The seller is also able to set a minimum price for the sale (reserve price) which if not met would result in the auction being aborted and no sale occurring.

·           Example

Numerous examples to mention however the £22.5bn UK 3G auction is probably the most oft cited procurement case study.

·           Strengths

Any English auction has the advantage of price discovery which is particularly useful for goods with an unknown or vague market value (art is a good example). The seller in an English auction does not limit the maximum possible bid ex-ante which is in contrast to other dynamic auction types

Exceptionally useful when there a high number of very closely matched participants.

·           Weaknesses

There are a number of weaknesses levelled against English auctions and I will try to summarise a few of them here. The first is that open auctions such as the English format allow for potential collusion amongst bidders. There are numerous papers on this subject and some high profile examples but it is a definite watch out.  Secondly the so-called “winner’s curse” is rampant in these auctions due to strong competition and incomplete information about the product being sold. In the long run, and I am writing this from the perspective of the procurement professional running the auction, although a fantastic price may be achieved it may not be sustainable. A third disadvantage for both buyers and sellers with the English auction is that everyone must be in communication over the course of the auction, which can be expensive and difficult.

2.        Reverse English Auction

·           Mechanism

Another one we are all familiar with. In a reverse auction the bidding price goes down and the buyer award contract to the supplier who bid the lowest price depending upon the buyer's specific needs with regards to quality, lead-time, capacity or other value-adding capabilities etc.

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·           Example

Pretty much everything…including stationary.

·           Strengths

Transparency and competition often yields exceptional results and also from a stakeholder management perspective vibrant reverse eAuctions are actually quite exciting to watch. A well-managed event, I will be doing a separate blog piece next week on the process that needs to be followed, ensures that everyone is bidding on exactly the same parameters. In markets which allow for multiple, reputable participants the reverse eAuction is a valuable tool.

·           Weaknesses

I have glossed passed the strengths somewhat because I am conscious that this article is more about other eAuction types available however it would be remiss of me not to Segway onto them by discussing some of the weaknesses of reverse English eAuctions.

There are three distinct advantages that exist for buyers. The first and foremost is that, if not managed correctly as per my previous post, that the ongoing relationship between buyer and seller will be irrevocably damaged. Jap (2000) reports of one instance where a supplier was so upset with their treatment they refused to bid for another seven years. Positioning from the buyers’ perspective is most definitely the key.

Related to this lack of trust is the fear of commitment. Sellers fear that buyers are simply awarding work based on the lowest price but will re-run the exercise (a la office consumables) once the contract needs to be renewed. Why would anyone commit any additional capital, tooling, training etc to such a relationship?

The third potential disadvantage for buyers is that too few suppliers will respond to the reverse auction announcement and a competitive environment will not develop. Although in theory, only two competing firms are required to conduct an auction in reality results are only really achieved when upwards of four or five suppliers choose to actively participate.

There are also disadvantages for the seller although I will only touch on them here. Primarily sellers are suspicious that the possibility exists that the buyer is only using the reverse auction as a negotiation ploy. The buyer may have identified a preferred supplier before the auction and has no intention of awarding business to the lowest bidder so any participant is really just time wasting. A second risk (and this doesn't necessarily translate to an advantage for the buyer, is that the seller may get caught up in the race. It is very easy to become exceptionally competitive and offer unreasonably low prices that may actually be below cost. It may also be true that a rogue bidder in the event has no intention on actually completing on their bids but drags down the entire supplier cost base as a result. Again this may or may not be seen as an advantage on behalf of the buyer, depending on whether the outcome is sustainable or not. For those wishing to see a nicely worked example of this last scenario I’d recommend the auction scene from the ‘Dad’s Army’ Christmas episode ‘The love of three oranges’.

3.        Dutch Reverse Auction

·           Mechanism

A Dutch auction involves an item being offered at a very high price, well in excess of the amount the seller expects to receive. The price is then lowered in decrements until a bidder accepts the price…one bid will close the entire auction.

A slight reverse on this, and more common in a procurement environment, is a reverse Dutch auction. Here the buyer specifies a starting price, price change value, time interval between price changes, and the reserved price. The auction opens with the first item with the specified start price and increases by the specified price change value after a fixed interval. The start price keeps on increasing until a supplier places a bid or the start price reaches the reserved price. Once the bidding is closed for the item, the auction moves to another item sequentially. The auction is closed when the bidding for all items is completed.

·           Example

Dutch auctions emanated, unsurprisingly from flower markets in Holland but in modern times the United States Department of the Treasury also raises funds for the U.S. Government using a Dutch auction. A variation on the theme has also been taken up by pricedrop.tv

·           Strengths

The primary advantage of Dutch auctions is speed. Since there are never more bids than there are items being auctioned, the process takes relatively little time to complete and actually from a buyer’s perspective are quite easy to set up. They can also be used quite readily when competition in the market is actually quite limited and traditional auction techniques may not yield results.

·           Weaknesses

The prime weakness of Dutch auctions and in fact of all non-traditional eAuction techniques is a lack of general understanding as to how the process works and as such the level of training that is required to ensure the smooth running of an event. Compounding this, although thankfully things are improving, up until very recently few of the eAuction service providers actually provided a Dutch auction solution and options are still less limited than one would like.

It should also be noted that in an event a Dutch auction would only see a single bid and as such the buyer would be blind as to how others may have bid in the event and how they stand in relation to the single bid received.

3.1.    Yankee Auction

·           Mechanism

Firstly a caveat, this is not something I have ever run myself however it is based quite heavily on the principles of a Dutch auction so I thought I’d add in a little section on the Yankee auction. Quite simply the buyer requests bids for a lot which consists of multiple units of the same item. Each seller can bid on part of the lot at a fixed price and at the end of the eAuction the buyer takes the lowest price bids, in ascending order, until a full lot is reached. As a quick example assume there were 100 items in a lot and bidder A offered to sell 50 items @ £100 each, B offered to sell 50 items @ £120 and C offered to sell 100 items @ £200 each then the buyer would allocate the full lot in a split capacity to both bidders A and C. The best way to imagine it would be a bit like ‘Dragon’s Den’ where they need to walk away with all the money but can solicit bids from multiple Dragons. Well that helps me visualise this anyway!

4.        Japanese Reverse Auction

·           Mechanism

My personal favourite eAuction form but please excuse my bias. The Japanese auction gives participants a few minutes to simply state whether or not they can commit to a dictated price level.  All those who said ‘yes’ are allowed to progress and all those who said ‘no’ are eliminated.  The price level then drops by a certain amount and the question is repeated to those who previously said ‘yes’.  The eAuction continues in this vein until all participants have ‘opted out’ of the auction.

Japanese Auction can be used in a forward, upward price direction, such as the negotiation of rebates amongst a supply base.  In this example as it is fairly meaningless to give suppliers feedback on their rebates in relation to the market (they could be providing different goods and services at different spend levels) the forward Japanese auction allows the buyer to negotiate with each supplier individually yet.

Since it is fairly meaningless to give suppliers market feedback on their rebates, as each supplier could be contracted for different goods and services and different spend levels, the Japanese Auction presents itself as a superb way to negotiate with each supplier individually yet in parallel and in a single auction.

Japanese Auctions lend themselves well to procurement professionals who prefer a negotiation restricted to their handful of preferred bidders as opposed to those who choose to proactively source from the wider market, assuming such a market exists at all.

·           Strengths

Japanese auctions are particularly popular with retailers as the approach can be a relatively successful one in markets dominated by a handful of major players or where general market liquidity is low.

Although I am not totally on-board with the ethics of this a Japanese eAuction can even be used for a single-source negotiation and has been used in this way in the past; achieving benefits where other auction types would obviously fail.

Other situations where the Japanese Auction can be used effectively are when there are large cost differences between bidders, despite both quoting for the same specifications.  With your typical Ranked Auction, the participant in first place is unlikely to be challenged, even though they may have some residual margins to expend.  However, utilise the Japanese Auction and even that participant will be asked to improve their offer.

It’s also often the case that whereas the winning bid in an English reverse event is normally slightly lower than the second best bid (why would they bid even lower when they know they are the winner?), in a Japanese, the most competitive bidder can, and often does continue to bid lower. So the buyer can benefit.

·           Weaknesses

The first problem, as is the case with Dutch auctions, they are not broadly recognised, which means participants will require a greater degree of hand-holding and reassuring.  Secondly, they offer little to the participants in the way of market feedback, although post-auction you can certainly provide feedback at your own discretion and to whatever extent you wish.  Thirdly, they operate in a rigid manner with participants only able to accept or decline each price level rather than to come in at their own price level.  It could mean that some participants have to wait a little longer to submit their final offer, although the end goal of establishing the market price is still achieved.

·           Example

Difficult to find examples and specific case studies but in 2008 a jumbo, black Densuke watermelon fetched a whopping £3,100 (650,000 yen) at a Japanese auction in 2008!

5.        Sealed Bid

·           Mechanism

A type of auction process in which all bidders simultaneously submit sealed bids to the auctioneer, so that no bidder knows how much the other auction participants have bid. The highest (or lowest depending on the auction form) bidder is usually declared the winner of the bidding process.

·           Strengths

Sealed bids are also used to ensure a “fair and open competition” where the buying organization does not have the opportunity to influence the bidding process or steer the selection of a particular company by sharing competitive bid information during the evaluation process.

·           Weaknesses

All the uncertainty related to the price of a product must be translated into a single bid, which cannot be adjusted when more information is revealed. Hence, if there is significant uncertainty about the price of the product being procured, the potential for an inefficient outcome increases since there is no price discovery.

Practical realities such as budget constraints and inter-dependency in the products’ values, in the case of multiple products, can make bidding in a sealed-bid auction exceedingly difficult unless the auctioneer allows the bidders to express these constraints in their sealed bids, which in turn can make it difficult to determine the winners.

·           Example

Often used for refinancing credit and foreign exchange, among other (primarily financial) venues.

6.        Vickrey Auction – Second price, sealed bid

·           Mechanism

Bidders submit sealed envelopes in one round of bid submission. The highest bidder wins the item, but at the price offered by the second-highest bidder (or, in a multiple-item case, the highest unsuccessful bid).

·           Strengths

The Vickrey auction gives bidders an incentive to bid their true value and allows for a focus on life cycle costing. The two-step approach can balance price and value in a manner that does not complicate the process and helps alleviate the practice of awarding business on the basis of the price tag only.

·           Weaknesses

The approach does not allow for price discovery and there is a risk that sellers use shill bids to increase profits – something that the buyer will need to be aware of.

·           Example

This type of auction is rarely used aside from setting the foreign exchange rates in some African countries.

7.         Elimination (aka survival) Auction

·           Mechanism

Multi-round sealed-bid auctions in which low bids are successively eliminated in every round with the low-bid price announced and needing to be met or exceeded in subsequent rounds

In the first round, all bidders submit a sealed bid. As a function of these bids, the auctioneer announces which bidders “survive” to the second round, a minimum bid for the second round, and, most importantly, all losing bids. In the final round of a survival auction the remaining bidders have seen bids submitted by all of the others and as such have some sense of the information possessed by the others.

·           Strengths

This approach combines the speed and predictability of sealed-bid auctions with the desirable properties of ascending-bid auctions.

·           Weaknesses

This isn't really an event favoured by buyers or sellers owing to the nature of the way the event is run.

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It is always possible of course to run a series of or a “multi-phase” auction, which may involve moving from a reverse English auction into a sealed bid or vice-versa etc. There are also probably multiple auction formats that I have not described in full detail here which I’d love to hear about!

I think the principle though is that there is an opportunity amongst the procurement community to vary their approach to the use of eAuctions and I hope this blog has provided a rough overview of the events available. In the next blog I will be discussing the ideal process to follow when setting up an eAuction and the potential pitfalls to avoid for both buyers and sellers.