Way to Global Optima- Effective contracting!

It is well known fact that a Contract is a multi-benefit instrument for procurement function.

Mostly, it is reckoned as a tool that outlines the roles and responsibilities of parties involved which also defines the rules for sharing of risk and benefits.

What gets unnoticed is the effectiveness of contracting to achieve or come closer to achieving global optima.

What is global optima?

To understand global optima, firstly one needs to understand what is local optima.

Local optima is the solution that gives the optimum value for that particular local function. Think of it as a particular dept. of supply chain, say transportation.

Transportation cost per unit would be minimum if full loading capacity of the vehicle is utilized to transport the items. That is the local optimum solution of transportation.

But if look at an overall supply chain cost, this local optima of transportation function can be detrimental as this might lead to increase in inventory carrying cost (storage, obsolesce, cost of money, material handling etc.) and hence, a sub optimal solution of overall supply chain cost.

Here our universe (global) is the overall supply chain cost which needs to be kept minimum as target.

In supply chain, which is actually not a chain but a complex network of multiple links (parties), one must try to strive for global optima to make it win-win solution for all the parties involved.

If it is not profitable for your suppliers, sooner or later, it will become non-profitable for you as well.

What does contracting has to do with it?

A buyer can frame the clauses, benefit and risk matrix in such a way that involved parties are motivated to maximum the overall profit possible and mitigate the risks involved.

Clauses like gain sharing or revenue sharing are few examples which look to incentivize both the parties fostering them to maximize the profit of entire system (global optima)

There are umpteen other mechanisms like buy back, discounts, cost reimbursable so on and so forth which when included at the right place in contracts, leads to an optimal supply chain.

It calls for a separate discussion on what kind of clauses can be included and in what conditions. Watch out this space for more on it..

Poka Yoke in Procurement

Poke yoke is a Japanese term that means mistake proofing or error proofing.

A simple example of Poka yoke is a microwave which doesn’t start without its door fully closed thereby negating any chances of an accident.

This concept can have a great application in procurement as well. In procurement, there are a lot of touch points wherein buyer is expected to take certain actions in order to be compliant to internal processes.

Most of the buyer activities are sequential in nature implying if one activity is not completed, the other activity should not be initiated. Because of this sequential nature, Poka yoke becomes a perfect instrument for implementation.

We will look at a simple example to understand it better.

Credit check is a critical due diligence check which is done to check if supplier can be entrusted with business.

If the supplier credit check has come out negative, the system should not allow buyers to either initiate a contract or release a purchase order to the supplier. In fact, system should not even allow the buyers to float RFQ to this supplier.

Similarly, in case of negative outcomes of anti-corruption & bribery or sustainability checks, system can be provisioned to deter buyers to proceed to the next steps.

Depending on the procurement strategy or in order words, organization priorities checks can be introduced to make it a mistake proof procurement system. To start with, if not all, we can identify the critical process and target them.

We need to be careful in introducing these checks as this might increase the lead time to close any sourcing project.

This might also frustrate buyers as they would feel handcuffed in doing their jobs. We have still not started talking about the pressure from business user who want the procurement job to be finished a day before sharing the requirement ;)

But the positives it can have, can save a lot of troubles for procurement and for the organizations.

These checks can be as simple as uploading necessary files or a quick review from somebody in system in order to allow buyers to move to next step.

Systems can be made little more intelligent to gain the positives and get rid of whatever negative impact it can have on sourcing process.

The implementation of poke yoke becomes a cake walk if there is as single portal for buyers to work on. It can become an exacting job if there are different portals/websites with no linkage.

APIs (Application program interface) can be the last resort in that scenario.

How to Run Effective Reverse E-Auctions?

Auctions are considered to be the best way to negotiate and achieve savings, provided these are run effectively. It dramatically reduces the time to negotiate the best commercials.

Below are some of the tips for buyers/procurement managers:

1.   Conduct an RFQ before Auction so that suppliers are fully aware of the line items they are bidding for. It is of paramount importance as E-Auction are generally run for short period and suppliers must know what is coming their way.In cases where LPP (Last purchase price) is not available, RFQ suggests the price which can be used as starting price for auctions.
2. Have hungry/new competitive suppliers for healthy competition.
3. Have the same T&Cs agreed with all suppliers (payment terms, penalty terms etc.) before making them participate in the auction. It is a best practice to share contract template as part of the deck for RFQ. Suppliers who don’t agree to non-negotiable T&Cs can be excluded at the RFQ stage itself. Different T&Cs make the comparison complex and lead to confusion during in-life governance of the contract.
   
4. Have limited line items in an auction so that suppliers can see all on one page w/o having to change/scroll pages. It shall not only make it easy for suppliers but would also lead to great results for buyers - Ideally 4-5 line items and surely not more than 10 line items
5.   Get technical/business buy-in on prospective suppliers before any auction to avoid hassles post auction. At times business refuse to assign business to most competitive supplier citing performance/technical reasons and L1 (most competitive partner) feels cheated for not getting business even after ranking at top in commercials. Ideally, suppliers which are ‘ok’ as per business should be the part of reverse auction. Auction is a transparent  process and it sends wrong signal in market if L1 doesn’t get major pie of the business. It also triggers the thought in other suppliers minds that auctions are not that important to get any business  which apparently means that the sanctity and effectiveness of auctions get compromised.
6. Have a clear thought process behind deciding the minimum decrement and time for which auctions needs to run. 20-30 minutes with limited extensions of 2-3 minutes is a safe way to go.

Happy to hear about the experiences and learning of other procurement managers.

Efficient Temporary Staffing Sourcing

Any sourcing project generally has 3 main objectives - Cost optimization, supplier reduction and compliance strengthening.

For any sourcing project, one can use a structured approach on the lines of DMAIC-Define, Measure, Analyse, Improve and Control, to ensure a sustainable solution is discovered and implemented for future.

Defining and measuring phase involves capturing current data, stakeholder collaboration, setting Objectives etc.

Analyse phase is the most important as it helps identify gaps in the current arrangements to get us thinking on possible solutions.  In this phase, we one start with as basic as 5W and 1H model- Why, Who, What, When, Where and How. It is to go deeper to explore potential areas of improvement which can then became foundation for the next phases.

 Some examples from an analysis phase for temporary staffing requirement are:

1) Why are we paying the agency?

Answer- Agency is recruiting and managing the payroll of Contractor staff. Recruitment is one time activity and Payroll is monthly recurring.

This insight is useful as mostly organizations pay as a % of salary which remains constant throughout the life of temporary staff.  One can leverage and formulate a new pay-out model to ensure that one time effort and cost is segregated. 

2) Who are we paying the fee for?

Answer- Temporary staffing requirement can be in different functions such as HR, Facilities, customer service, IT etc.

This is a useful information as effort required to recruit a candidate in niche jobs is much more. One can design 2 different pay-out matrices based on type of staff, thus avoiding cost leakages in paying same level of costs say for a Facilities contractor vis a vis an IT/Networks Engineer/ Project Director.

3) What is the break-up of cost?

Answer: Find out with spend analysis whether you are paying mark up on reimbursements.  Mark-up on reimbursements should be completely eliminated.

4) When are we making the payment?

Answer- There are two models prevalent in market i.e. ‘pay & claim’ and ‘claim & pay’. In pay and claim suppliers first disburse the staff salaries and then raise the invoice to clients. Claim & pay works just the opposite. Try and tweak it to get tangible commercial benefit.

5) How are we paying the agency?

Answer- Generally organizations pay % of Salary of staff. Suppliers have all the reason to share candidate profiles having higher salaries (so that suppliers get paid higher agency fees). It is akin to a scenario where a transporter is being paid on the basis of Kilometres travelled 'sans' any guidelines on route directions.  This insight can be  leveraged in framing a pay-out model wherein instead of Agency fees as % of salary, a flat fee is paid.

Analysing and improvement phases can run hand in hand through brainstorming sessions with business stakeholders.

Once a buyer realizes the gaps in  existing commercial model, it makes the job easy to design a more effective framework and commercial model.

Designing an efficient commercial model is followed by standard sourcing cycle - Approach Suppliers (Incumbents and new prospective market players), launch RFI, shortlist basis RFI and then conduct formal RFQ with the shortlisted suppliers.  Negotiations is most effectively done using reverse e-auction tool, the fastest and fairest tool for effective negotiations.

Control phase in sourcing can be to close a long term contract, ensure all requirements and clauses are captured and monitored timely.

So how are you dealing with this category in your organization?

MSP, A growing fade!

35% savings in print/POSM material purchase, WOW!. 30% savings in temporary staffing, just WOW!

And with rationalization in number of suppliers, it is a pure gold!

I have been lucky to have completed multiple sourcing projects and make a positive impact with various initiatives.

MSP is surely one of those initiatives.

Business owners love it as they have less people to manage and far better results.

It’s a win-win for both i.e. business owners and procurement.

Where it is applicable: When you have multiple suppliers to manage and they all work at varying costs. And where you see or don’t see an opportunity to reduce cost. Doesn’t matter!! Saving would definitely come if it is done in a proper manner. It doesn’t need to be for one item/service but can work for entire category or set of similar goods/services.

Where it works well: Geographically, when you are taking supply and services within a country instead of multiple countries. Though it can also work there but it works well when it is within city/state/country.

What is MSP: Managed service provider which manages the suppliers efficiently and effectively to ensure goods/services are delivered as per expectations.

What do you need to get started: Spend data, suppliers information, SLA/KPIs applicable and Voila! You are good to go!

Step 1: Analyse the Spend. What items/services are being purchased and what are their specs/SOW.

Step 2: Look for standardization but not at the cost of business. An example if the organization is buying posters for marketing communication, and is buying posters of different sizes and GSM, then talk to marketing to seek opportunities of standardization. Less the variation, the better would be the outcome. We would be able to use economy of scale to get better financial benefits. (Standardization is not a mandatory step before going for MSP but if done, can give great rewards)

Step 3: Once the items/services are standardized and KPI/SLAs are known, we may share it with prospective MSP suppliers. They would ask for volume forecast, delivery location etc. which needs to be provided so that can go out in market and explore on your behalf.

Step 4: Review and select good no of prospective suppliers. Discuss what is expected of them. More the number of quality suppliers, greater the benefit. Talk to business owner, google it, search your repository as key is to find sufficient number of interested parties.

Step 5: Suppliers can be shortlisted basis RFI (Request for information) which can include their revenue, current clients, presence in required locations, office locations etc.

Step 6: Formulate the commercial model. Formulate because it needs to be scientific. It needs to be designed carefully and intelligently. For example of posters. Price may significantly vary if you are buying 100 posters instead of 100,000. So make slabs so that you can get the benefit when volume is higher. Every business has fixed cost and variable cost. Higher the quantity, less would be the fixed cost/qty.  One major factor is to study the current trend as well. If most of the times, you purchase it in higher quantity lot, it doesn’t make sense to have slabs for lower volume. For example, if 90% of the times, you have ordered in excess of 5,00,000, 10% times lesser than 500,000 and 70% times between 5,00,000-10,00,000 then we need to target the volume slab of 5,00,000-10,00,000 more.

Step 7: Decide whether you want MSP to manage your current set of suppliers or you want MSP to ensure goods/services are delivered as per fixed KPIs/SLAs, no matter who is supplying at back end. That’s a decisive step. Suggestion would be to let MSP explore in the market rather than working with your set of suppliers. Reason being that current set of suppliers will not be willing to reduce cost and having an MSP would add up the management fee to current cost. We may suggest 2-3 suppliers during the transition period to mitigate risk but in long term, it works beautifully if MSP decides the supplier set and we decide the item/services, specs/sow, KPI/SOW etc. It has other benefits as well. It will make MSP the owner like it should be. In case of any delay, MSP should not come back quoting that our supplier is not delivering. If MSP decides the supplier, it would take complete ownership.  Moreover, MSP will go all out and use its expertise to negotiate the best cost with supplier. Have a penalty matrix in place with MSP in the contract/agreement and monitor it regularly.

Step 8: Conduct a RFP with your commercial model. This would help MSP to get familiar with commercial model, KPIs/SLAs, penalty matrix etc. Prospective MSPs can then go to market and get best cost for us. MSPs are expected to quote the end cost i.e. including their margin. Buyer can compare the cost with existing and see whether it is making any sense. If the cost if on higher side, don’t get disheartened as negotiation holds the key.

Step 9: Conduct reverse (E-auction) auction: It is not a mandatory step but an important step which might make/break the decision of having an MSP in place. You will be surprised to see the results and difference b/w RFP and auction rates.

Step 10: Compare the commercials to know which MSP has given the best commercials.  Evaluate other parameters as well as per your organization process and select the most preferred supplier. Calculate the savings comparing old model and proposed MSP model. Close the contract/agreement and you have reached the stage where you can reap the benefits of your hard work.

Elixir for Organization-AMC Management

Organizations used to have a secret sauce which gave them an advantage over others. Today, the scenario is different. In the age of communication, it is not difficult but impossible to hide what you are doing.

Now when there is very differential, it is of paramount importance to do the business efficiently so that enough value is created for all stakeholders.

Efficiently doesn’t mean that doing the job at lowest cost possible but getting the work done at optimum cost without compromising on quality and without exposing the organization to undue risk.

AMC management is an ever existing, industry agnostic area, every organization deals in.

Organizations, be it any industry, purchase a lot of capex equipment every year and these have to be maintained to support business operations with limited/permissible down time.

A simple example would be an AC running in offices, or generators for power back up. We will find plenty of equipment that run to make business run.

Higher lead time or in other words higher down time exposes the organizations to a huge risk. Operations can come to complete halt and strategic customer can be lost within a span of few seconds.

That is how critical it is to maintain all critical equipment.

From procurement perspective, AMC is a recurring cost which mostly increases with time and something in which business doesn’t want to take any risk.

Be it introduction of new AMC partner, shifting from non-comprehensive AMC to comprehensive (There can be different type AMC services which are discussed in a another of this blog), changing the SLAs so on and so forth, all expose organizations to some amount of risk.

Procurement needs to work in such a manner that business is delivered as expected and right cost is paid for it.

AMC management has different parts to it. It is to do with managing inventory of all assets (which is dynamic in nature), it is to do with tracking warranty dates, it is do with having updated partner details and maintaining the record of all maintenance activities, TTR (time to repair), records of downtime, performance records so on and so forth.

In this article, I would like to focus on the concept of Poka Yoke in AMC. To ensure that all activities pertaining to AMC are done effectively with no or significantly lower scope of failure.

The objective is to ensure that AMCs are renewed on time so that AMC partner can provide continuous support and at right cost.  If AMCs are not renewed on time, it may lead to exorbitant reinstatement charges as well.

Elixir for organizations when it comes to AMC management: AMC Management software and its effective usage.

Who are the OEMs of well-designed/developed AMC software are covered in another article.

AMC management system shall capture inventory of all assets, will send auto triggers to concerned stakeholders on nearing the warranty/AMC end date, shall capture the partners who are doing it with the cost and performance which will come in handy while selecting suppliers for next cycle. It will provide a single window exhibiting when the asset was purchased, from whom, what is the warranty period, which issues were faced and resolved, what is the cost trend, is the product obsolete (out of sales/support) so many other important information which is useful for buyers as well as business users.

It provides a systematic and scientific approach to deal with AMCs.

It can provide a much needed visibility and most importantly an edge on efficiency which does a long way in running the business the way it should be.

Process changes one can do to save on AMC cost is covered in another article on this blog.

Connection between Contract Management, Risk mitigation & Cost reduction

Today, almost 75% of the procurement globally is based on contracts/agreements with their life term ranging from 6 months to 10-15 years. Once the procurement contract is established with the vendor, purchase orders are created and released as the need arises for product/services during the year with some exceptions in the process when purchase orders are not created owing to confidentiality/strategic reasons. Process of ‘goods/services receipt’ and ‘payment making’ follows as per contractual terms. Timely monitoring of performance of vendors based on quality/cost/delivery time/service support to leverage the best amongst available opportunities forms the next step in contract management.

Due to involvement of numeral complexities and given their long term/inherent nature, contracts expose organizations to multi level risks. Ever surging complexities, regulatory requirements, involvement of huge sums and many other business requirements( cost reduction/vendor alliances/responsiveness etc.) make activities ;negotiations (multi level), collaborative authoring from business stakeholders, procurement experts, and legal professionals, multiple approvals, adherence to compliances and monitoring vendor’s performances ; critical and all the more important in a growing organizations. Now challenge remains in executing these activities to have an efficient and effective contract management system. Current systems used are manual and lack integration in above mentioned activities and thereby poses a risk to supply chain of any organization.    

    

Functional requirements:

·         Reduction in ‘Time to contract’

·         Efficient tracking/monitoring of vendor’s performance

·         Proper governance and efficient /effective version management

·         Spend visibility

·         Security of confidential contracts/documents

·         Collaboration and high user adaption among key stakeholders

·         Adherence to regulations and compliances

·         Lesser risks and thereby disputes through greater transparency

·         Better business relationships

·         Effective financial management

System requirements:

Above mentioned functional requirements can be achieved through a contract management application which will help in:

·         Contracts standardization

·         Flexible work flow expediting necessary approvals

·         Streamlined amendment process

·         Central Contract repository providing full visibility

·         Integrated and automated system to track vendor’s performance vis-à-vis contractual terms

·         Parallel Negotiation of Commercial & legal terms reducing redlining & cycle time

·         Compliance tracking

·         Reduced manual processes and contract administration workload

·         Automate standard processes

·         Involves business partners (Interactive management)

·         Shorten Contracting Cycle (Time consumed in establishing  a contract and administrative activities during the life span of a contract)

Listed below are the benefits, financial as well as process centric that any organization will gain after the implementation of Contract management module.

#	ROI Potential	Potential benefits in first year itself *
1	Streamlined operations (faster processing, headcount reduction)	75-100%
2	Performance Management	10-30%
3	Risk mitigation	40-50%
4	Improved financial management	50-75%
	Total potential benefit in first year	175-255%

Burlinton Northern and Santa Fe Railway Company (BSNF), Interpolis Verzekeringen and Hewlett-Packard (HP) have reaped benefits on similar lines and have reached break even within 6 months time.

Detailed Justification of factors contributing to ROI

1)    Streamlined Operations

o   Reduced time to create and administer contracts: Time and effort to track and administer contracts can be greatly reduced. Standard templates and clauses based on requirement can be utilized. Auto reminders based on expiry date can also be set.

o   Improve process efficiency throughout the contract life-cycle: Optimizing processes related to creating business contracts

o   Reduce manual processes and contract administration workload: Manual intervention reduces directly impacting work load on buyers

o   Streamlined amendment process

o   Consolidate contract databases/repositories: Contract administrators can access the complete record of purchase documents and interactions related to a contract. They can also tracks deliverables and drill into all relevant documents

o   Leverage standard templates

o   Eliminate duplicate entry

o   Eliminate ‘shadow’ systems and tracking mechanisms: Excel sheets and other mechanisms being used can totally be eliminated

o   Support unique processes in different business units: Standardization across regions

o   Improve reporting: Accuracy improved and MIS reporting time reduces

2)    Performance Management

o   Identify and ensure delivery of contract benefits: Tracking deliverables timelines/quality/quantity including completion of services

o   Monitor and manage compliance and performance: Performance metrics may be designed based on actual and forecasted deliverables

o   Penalty clauses clarity and accountability: Based on vendor performance and user’s remarks penalty clauses can be focused

3)    Risk Mitigation

o   Identify and manage risks: Allows users  to monitor the factors when it exceed a threshold ex. dollar value

o   Ensure proper controls of standard templates: Automatically insert a  required approval whenever specified template text has been altered

o   Provide audit trails: Any contract modification, review approval, rejections, renewals including  who and when information is tracked

o   Ensure strong security: Read only, update, delete etc rights may be used

o   Enforce policies: Workflow processes as per rules/policies

o   Monitor compliance of contracted parties: Ensures notifications are automatically sent out in a timely manner and identifies when compliance items represent a risk

o   Identify and manage sensitive contracts:  Special business rules can be applied based on sensitivity ex. high spend contract, high profile contract

4)    Improved Financial Management

o   Eliminate renewal of contracts for unwanted goods and services: Visibility enhancement can help in removing “unwanted contracts”

o   Improve financial tracking of contract-based transactions

o   Identify and prevent overcharges: Transparency and close vigil can prevent overcharges across the system on contract based payments

o   Realistic picture of forecasts and budgets relating to expenditures

o   Improved cash flow projections

PricewaterhouseCoopers:  Companies could realize savings that equate to 2% of total annual costs by eliminating inaccuracies and noncompliance through contract automation.  Therefore, a company spending $1 billion could save $20 million annually

Goldman Sachs: A typical Fortune 1000 organization has between 20,000 and 40,000 contracts and spends as much as 100 basis points of their revenue to manage buy-side contracts, and 25 basis points of their revenue to manage sell-side contracts. They estimate that these enterprises could experience a potential reduction of 40 basis points in hard and soft costs by using contract management software. Contract automation could accelerate negotiation cycles by 50 percent; reduce erroneous payments by 75 to 90 percent, cut operating and processing costs associated with managing contracts by 10 to 30 percent, and result in a 10 to 20 percent headcount reduction.

Aberdeen Group:   Ineffective control and management of supplier contracts cost businesses    $153 billion per year in missed savings opportunities.