“Consolidating suppliers within specific supply markets is a proven strategy to concentrate buying power and reduce purchase prices. The activity can be taken further, though, especially within non-production (indirect) spending areas . . . Consolidating suppliers within specific supply markets is a proven strategy to concentrate buying power and reduce purchase prices. The specific business benefits include . . .”
Speechless and left wondering what were they thinking are the immediate descriptive phrases that come to mind when I reflect on the recent Hackett Group research article on supplier consolidation. What is equally perplexing is the fact that they focused on Indirect Material spend as the basis for supporting the viability of their position.
Right off the bat I want to stress that supplier consolidation makes sense when strategically applied to specific areas of procurement such as in the acquisition of complex products that require highly specialized and ongoing support. Of course consolidation in this area might be a moot point in that when we enter the realm of specialized equipment the field of suppliers with whom one can deal is already naturally limited.
However, by referencing Indirect Material spend and supplier consolidation in the same breath, Hackett demonstrates that they are stuck in the bygone era of traditional ERP-based applications that were best suited to low volume, high dollar transactions. In other words, these monolithically cumbersome programs were the true impetus behind supplier rationalization strategies as opposed to a viable business metric or imperative.
As I had indicated in my December 18th, 2013 post 3 supply chain concepts that should finally (and mercifully) be abandoned in 2013; “In a world where both public and private sector organizations are looking for a marketplace “that never stops growing and always allows both contract and non-contract participation,” these ideas – which have always been bad by the way – are the antithesis of the new B2B world.”
Now one might think that I am just providing an opinion. Maybe so but, my opinion is based on hard fact resulting from my government funded research in which I identified the existence of commodity characteristics. You can read about it in my Dangerous Supply Chain Myths post on Enabling Technology and the emergence of the Metaprise however, over a 14 year period we discovered that all commodities consistently fall into 1 of 2 categories – Historic Flat Line and Dynamic Flux.
A Historic Flat Line commodity is characterized by a static price performance where there are minimal cost fluctuations over an extended period of time. It is further accentuated by a “narrow” floor to ceiling price chasm. Direct Materials as well as specialty products such as scientific and medical equipment commonly exhibit Historic Flat Line characteristics.
A Dynamic Flux commodity is characterized by a dramatic and consistent fluctuation in cost that is mirrored by a steady downward price performance over an extended period of time. It is further accentuated by a wide (usually significant) floor to ceiling price chasm. Indirect Materials and in particular MRO commodities commonly exhibit Dynamic Flux characteristics.
The reason that commodity characteristics are important is that the absence of this knowledge has been a major contributor to both process and technological misalignment. The kind of misalignment that has usually been championed by papers and articles such as the one being presented by The Hackett Group. This is due to the fact that by applying the same purchasing process used for Direct Material (Historic Flat Line) procurement to Indirect Material (Dynamic Flux) commodities, the perceived volume discount savings are virtually negated within a very short period of time (in some cases almost immediately). This is one of the factors that fuel the buyer refrain that they can usually beat the centrally negotiated contract pricing with a single phone call to a local supplier.
So in reducing the number of suppliers with whom they dealt, organizations lost touch relative to actual market pricing trends. The end result was one government department had paid on average more than 23% above the going market price for their MRO products, while a major American retailer experienced a similar outcome with their rationalization initiative.
The sad part is that The Hackett article focuses on supporting rationalization by referencing what amounts to an artificially narrowed supply base, while simultaneously ignoring the emergence of the new cloud-based solutions. Unlike the ERP applications of the past, this new generation of solutions create the means through which organizations can easily and conveniently engage more rather than fewer suppliers.
Once again, what were they thinking?
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Procurement Insights 
Pete
April 30, 2014
Not sure why you are shocked. I read the paper and it seems pretty straightforward. Firms that rationalize their supply bases tend to drive more savings. This has been going on for firms early in their procurement journeys for 20+ years. For indirect and for direct – it’s the same – and actually even more for indirect because the tail gets long and switching costs are lower.
I do agree that there’s only so far you can reduce, especially when you have to support diversity/SMB/etc needs, and that’s when you have to look for other value with the supplier through SRM programs, which I think the paper was also pointing out.
Your other points only confuse the issue….
Price benchmarking doesn’t diminish sourcing and supplier rationalization – it merely informs it.
Your term “artifically narrowed supply base” is also meaningless. Nothing artificial with a supply base reduction. Maybe it’s short-sighted by being overly focused on price reductions through volume leverage – but it’s not ‘artificial’
Cloud based vs. ERP is meaningless. First all the ERPs are going cloud. Second, supplier rationalization is driven primarily by spend savings – not by process efficiencies. Those efficiencies do help free people up to hopefully drive more value.
I won’t even even touch “Dynamic Flux”. Sounds like the DeLorean in ‘Back to the Future’! 🙂
piblogger
April 30, 2014
Thank you Pete for taking the time to detail so well your position regarding rationalization. However, you have failed to substantiate your statement that “firms that rationalize their supply bases tend to drive more savings.” Where is the data supporting this position, and supporting it from the standpoint of consistent savings across industry sectors.
While it is certainly your option to dismiss Dynamic Flux and Historic Flat Line commodity characteristics, the research data clearly demonstrates that the referenced tendencies do in fact exist with both Indirect and Direct Material items respectively. Here is the link to the Acres of Diamonds White Paper providing the data to support the above; http://www.slideshare.net/piblogger/acres-of-diamonds-an-early-saas-savings-model
From a practical standpoint, and referencing buyer-side organizations in both the public and private sectors, we found that in rationalizing their respective supply bases both the Department of National Defence and Best Buy paid higher than the going market rate for Indirect MRO materials relating to the support of their IT infrastructures. This creeping margin effect occurs when the data pool from which purported rationalization savings is based upon, is derived from a diminishing pool of suppliers rather than the true market as a whole. It is pretty straight forward actually. After all you can’t manage what you can’t measure. Logically speaking, how can you measure the market price index when you are only dealing with a relatively small percentage of suppliers.
As to your statement regarding ERP versus cloud-based solutions, I am not certain that you are really zeroing in on the real issue, which is the well documented inability of traditional ERP-based procurement solutions to deliver the anticipated savings. This is not breaking news as it is generally accepted that 80% (some put that number even higher) of all ERP-based procurement initiatives have failed to deliver the results. I do not think that it matters whether ERPs remain on the ground or take to the cloud.
In short, broadly applied rationalization strategies do not work. The fact that the marketplace is moving towards increasing supplier engagement rather than limiting it, speaks volumes.
Pete
May 2, 2014
John, let me help you ‘unpack’ and respond to some of your points to help you out.
First, the data that I’ve seen from every firm who’s analyzed this: Hackett, AT Kearney, CEB, CAPS Rersearch, Aberdeen, etc. shows the same relationship between spend savings and supply base rationalization. I’ve seen hundreds of presentations from procurement organizations seeing this in their individual transformations. Suppliers simply give better pricing on volume deals. Not sure why you’re going to war against Economics 101.
I read your dynamic flux ‘aces’ piece. It’s from 2005 and based on a single public sector firm with <$250M spend. Regardless, your point is fine that it'd be stupid to negotiate something like 5 year fixed price contract on an item where costs are expected to drop. But, most private sector firms are not like the GSA (in US), and they do shorter term deals, and for SKU-based items, they will either negotiate a % off list or have a meet-beat clause to ensure that pricing is competitive. And I'm seeing more companies encouraging feedback from eProcurement back to sourcing to keep the contracts relevant.
Now, whether sourcing is including enough SMB/diverse/local suppliers is a separate issue that I mentioned before. Smarter companies are more balanced in 'rightsizing' the supply base, not just downsizing.
Your point about the 80/20 on transactions is a separate point, and you are in fact arguing against yourself here. Having everyone out there finding the 'best deal' locally might be fun for those with time on their hands, but molecular biologists should be discovering drugs, not price shopping for beakers. Your solution is like in public sector – load everyone up with high dollar limit p-cards and let them go to town. Unfortunately, the authority to spend their budget shouldn't be confused with giving everyone the authority to contract. This is why private sector do use p-cards, but at lower dollar limits and/or for emergency purchases.
Re: cloud vs. ERP, again, you need to clarify your thinking and unpack these issues. Lack of demonstrated ROI is certainly harder when you have a bigger "I" from on-premise deployments (vs. cloud), but you'll fail if you apply ANY technology without broader process/org change – regardless of the name you give it, or how it's deployed technically or financed.
Not sure your point on 'supplier engagement'. Most modern procurement organizations do supplier rationalization to minimize un-needed interactions with superfluous suppliers, so they engage more meaningfully and deeply with strategic/critical suppliers to drive more value – and to pursue newer activities in revenue growth, sustainability, etc. Deeper/better engagement is enabled by right-sizing the base, not by allowing supplier anarchy to meet local whims and chummy supplier relationships. It's time to enter the 21st century world here.
piblogger
May 3, 2014
While I appreciate your helping me to “unpack” Pete, the clothes are unfortunately ending up all over the place.
So let’s simplify and keep the clothes in one neat and tidy place. And we will do this with one word; eVA.
Here is the link to a recent post regarding Forrester’s assessment of Virginia’s very successful eVA initiative which is based on expanding as opposed to rationalizing the supply base; Revised Forrester Wave Report confirms what I have been saying since 2007 . . . eVA is tops in public procurement (http://wp.me/p4HrB-3O6).
Since 2007 I have been tracking eVA making particular note of the distribution of business over an ever expanding supplier pool. The following data is quite interesting:
With eVA, 1% of the total identified spend of $3.5 billion was processed through the program in 2001. In 2007 that number has increased to more than 80%.
Simultaneous to increasing throughput, is the growth in the Commonwealth’s supply base from 20,000 in 2001 to 34,000 in 2007. What is worth noting is the expectation that the level of vendor acceptance will likely continue as demonstrated by the fact that the distribution of business over the entire supply base has also increased substantially. Data provided by Virginia indicated that just 6,000 of the 20,000 registered suppliers received orders prior to eVA’s introduction in 2001. Nine months into 2007, 14,756 of the 34,000 registered suppliers have already received orders.
This trend has continued on an upward trajectory, and has delivered tremendous savings to the Commonwealth. These savings have been so significant, that Virginia is now looking for ways to engage all suppliers in the State whether they are on contract or not.
Of course this trending isn’t limited to the public sector.
As previously indicated, private sector organizations are cluing into the fact that a rationalization strategy that is broadly applied across an enterprise’s entire spend does not work. I guess the fact that 80% of all ERP-based eProcurement initiatives having failed to deliver the expected savings results have dampened the enthusiasm for this strategy. Has had the resulting problem of maverick spend.
The auto industry’s PTDA Association did a study a few years ago and found that despite the existence of centrally negotiated volume discount contracts from a rationalized supply base, 37% of all spend in the sector in the US was from off contract suppliers. This number rose to a whopping 79% of all purchases in Canada. So is this a case of wanton buyer insubordination?
Besides the challenges with cumbersome ERP-based procurement modules, maybe just maybe, the buyers know something in terms of which suppliers not only offer the best price but, the best value? Unfortunately, these suppliers often find themselves on the outside looking in as a result of rationalization strategies that include skewed qualification guidelines, and a cumbersome P2P process.
So within the context of the above, and the fact that the industry is moving towards expanding rather than rationalizing supply bases, one has to wonder what you are debating.
My research clearly indicates that rationalization strategies do not work. You believe that your research tells a different story. Considering that the market will ultimately decide which path is the one to follow in terms of what does and does not work, I am more than happy to let those chips fall where they may.
Let’s revisit this discussion a year from now.