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Beware Primitive Thinking

November 9, 2010

I am told that the latest target for Procurement is ‘the elimination of sole source supply agreements’. Apparently the most recent ‘best practice’ thinking is that sole source always equates to higher prices and therefore opportunities for savings – typically around 15%, acording to my source.

This news, if true, represents yet another example of the simplistic – indeed, primitive – thinking that comes from many advisory firms and consultants. It is one more illustration of the confusion between price and cost – and unless Procurement starts to demonstrate understanding of the difference and fight for new value measurements, its relevance to the business will continue to be narrow and marginal.

It is certainly true that sole source suppliers – like long-term incumbents – can take the customer for granted and fail to maximize their value. But in many cases, security brings levels of alignment and trust that result in substantial cost savings, continuous improvement and innovation. If these are absent, it may have little to do with the threat of competition and more to do with the weakness of performance and relationship management.

The US auto industry was a case in point where aggressive use of competition caused relationships and loyalty to be fractured. Recent reports suggest that sole source supply arrangements are re-surfacing in a big way, as part of the rebuilding of the industry. There are many occasions where the price of the commodity is but a fraction of the total cost of the relationship. Cheap prices do not generally result in high value relationships. And poor relationships certainly do result in higher costs.

Sophisticated sourcing groups are smart at economics. Unfortunately they are relatively rare – not least because the measurements used to measure Procurement success remain so narrow. Many times, it is the CFO who is to blame for this. Their refusal to allow a change – or increased balance – in Procurement metrics is damaging the bottom line. An unthinking attack on sole source supply relationships would be yet one more example of failure to understand true costs and the wider business interests.

3 Comments
  1. Syed Khan MCIPS., C.P.P., C.P.M. permalink

    Hi Tim
    thanks for bringing up another important and relevant issue., you rightly mentioned what happened to the US car Industry when they started cutting costs on expense of quality., there are several industry that heavily rely on ancilliary industries for parts and components, and optimizing the costs through JIT i.e Toyota, this could only be possible with that level of collaborative approach and partnership and sometimes vertical integration. that not only makes economic sense but also garantees continuos and quality supplies. It showed that the risk of failure out weighs the savings and one has to be extremely careful in such high stake decisions

    • Syed, thanks for your comment and endorsement of the point that we must be careful in how we apply ‘savings mechanisms’. I guess the real point is that one size fits all solutions do not work and we must apply judgment. The interesting question is whether anyone has developed truly robust criteria to assist that judgment, to determien the optimum form of relationship and contract strategy that will elicit the greatest value. One thing that I am sure about is the need to consider value and cost for both sides – not just your own.

      Tim

  2. Sandy Keeney permalink

    Competitive bidding works well for commodities, but if an organization wants to take advantage of developing technologies there is no option but to award sole source.

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