Wednesday, August 31, 2011

Compliance with Laws

In procuring from a supplier you want the supplier to comply with any necessary laws, so there is no barrier to the work being performed or your ability to use the product or service. That always creates the issue of what laws need to be complied with. Different industries can be subject to different laws. Different cities, counties, states and countries all have different laws. Does the law of the location where the sales is made control the laws that must be complied with? What if the purchase is to be shipped or delivered to a different location? Do those laws also apply? Even different products can have different requirements.For example data communications equipment is subject to what’s called homologation requirements (meaning certification, confirmation of approval before it may be used with that locations communications network). The EEC also enacted the RoHS Laws (Restriction on Hazardous Substances) to prevent products that had hazardous substances from being imported into EEC countries. A supplier may not have needed to comply with those laws if they didn’t want to sell into the EEC or weren’t selling their product to someone that used it in their product who intended to sell it in EEC Countries.

Suppliers usually have three major concerns with any compliance with laws requirement. One is being able to know what the requirements are for every location that their product may be shipped to.The second is any change in a law can have a cost impact that may have not have been taken into account in the agreed pricing. The last is even if the price could be adjusted, could they or would it be economically feasible for them to implement all of the changes that might be required to comply?.

When you procure services the issue of compliance with laws is easier as the law of the location where the service is performed is the only law that would apply. Where it becomes complex is with products. With products you have multiple points that need to be taken into account: The laws of the location(s) where it’s produced; the laws of the locations where its delivered to; and the laws of the location of the end customer.

There are three different approaches to dealing with the issue of compliance with laws. Each has both pluses and minuses. One approach would be for the Buyer to spell out all the various laws that the supplier must comply with. If a Buyer is spelling out specific laws that must be complied with there are several risks. One is they may be requiring compliance when compliance is not required and that adds to their cost. A second risk is potentially limiting the laws that do apply. Any time you include a list you may be limited to only what you listed. The third issue is you need to keep track of any changes to those laws and if those specific laws are changed,you need to amend the agreement to update it.

A second approach is to leave it vague and very open-ended. In this the Buyer may require that the Supplier comply with all applicable laws. Suppliers do not like this as frequently they may not know all the locations where the buyer may be using or shipping the products into so it makes their risk of complying with laws higher and their burden to track the laws and changes to the laws greater. Many times their approach will be to try to limit the specific locations or countries to a limited number of countries that they already do business in where they have to manage compliance

A third approach is to have a form of combination of approaches where you specifically spell out specific laws or countries laws that must be complied with but include those only as examples so the requirements include but are not limited to those laws or locations listed to prevent the lists from being considered all inclusive.

While a Buyer may want to have the broadest coverage, there are many times where that may not be feasible, practical or cost effective. There are one hundred ninety-six countries in the world. I don’t know how many political subdivisions exist but than number has to be in the millions. All of those can be passing laws. What’s the best solution? This is similar to a problem I had when I was procuring power supplies. There were at least eight different voltages that were in use in the world and in remote islands off Japan other voltages were used. You also have two main frequencies 50 or 60Hz. Trying to design a power supply that would have worked in all locations would have been extremely expensive. So we made the business decision to limit the design parameters to only those locations where we knew we would have significant sales where we need the products to work at the right voltage and frequency. The same approach may be the best solution for compliance with laws. Focus on those locations where you know you will have significant sales. Suppliers will be happy complying with those as it means more sales to them. Then if you see significant opportunity in a new market approach the supplier to have them comply with those laws.

Tuesday, August 30, 2011

Avoiding Contract Problems

In a post on Linkedin, a writer shared their tips on avoiding contract problems. I decided to take that one step further here, To make it even more valuable to the reader I decided to cross reference the specific point to all the applicable posts that I have written that apply to that point. My goals was to have you understand the issues better and also how to manage them.While the blog's Title is Knowledge to Negotiate, you will see that many of the posts I've written are also about avoiding contract problems.

1.Take the time in advance to qualify the potential supplier to ensure that they and their team will be capable of performing the work.See posts on Supplier Financial Analysis Jan 26, 2011,
Supplier Surveys August 12, 2011, Supplier qualification August 8, 2011 and Interviewing April 8, 2011, Checking References Jan 26, 2011.

2.Spend time with you internal customer to understand their needs and goals.See post on Communication - Internal Questions to ask in preparation April 8, 2011

3.Document all requirements and expectations.

4.Make sure that the specifications, statement of work or scope of work is clearly written and defines all the things that are required for performance.See posts on Writing Specifications, Statements of Work and Scope of Work July 4, 2011

5.Make sure that the contract is unambiguous and clearly written.See posts on Active Voice December 12, 2010, Compatibility between documents April 7, 2011, Contract Drafting with Precision April 6, 2011.

6.Make sure that the contract has the necessary tools to manage the known risks with the Supplier.See Procurement Risks Jan 18, 2011, Managing specific Risks Jan 11, 2011 and Jan 19, 2011 Quantifying Supplier Risk Jan 18, 2011

7.Make sure the contract has the tools necessary to drive the supplier’s behavior and to manage their performance.See Managing Performance February 6, 2011, Structuring Contracts to Drive Behavior Jan 7, 2011.

8.If multiple tiers will be involve in the work,require approval over who those suppliers will be.See Subcontracting - Negotiating Subcontracting Rights Feb 10,2011

9.Make sure that the contractor or supplier will manage those suppliers and you have the right to engage those subcontractors when there is a problem.Make sure the supplier is clearly obligated to or manage their subcontractors performance.

10.In your negotiation make sure that you have included the right standards of commitment for performance and have not agreed to carve outs or language that would dilute the commitments of the supplier. See Standards of Commitment January 11.2011,Qualifying words January 13,2011

11.Make sure that you have the right remedies included in the event of non-performance. See posts on Remedies Jan 23, 2011 and April 11, 2011

12.Make sure that actions that would constitute a material breach of the contract are clear.See Breach April 11, 2011.

13.Make sure that the types of damages and any limitation on either the type of damages or the amount of recovery are applicable for the damages you would sustain. See Damages March 24,2011.

14.Staff the program and management of the contract with the appropriate level of resources for the contracting approach you have used and the risks and performance you need manage. See Contracting Approaches July 2, 2011

15.Hold regular performance review meetings to measure and track performance.See Managing Performance February 6, 2011

16.Understand the supplier’s management chain and escalate problems and performance issues to them by holding periodic management review meetings. Escalate issues directly to them when you make no progress with the program team. .See Managing Performance February 6, 2011

17.Document everything in writing and use action item lists that get shared to management to identify open issues, status, time for resolution.See Contract Management April 6, 2011.

18.Manage the contract file so that at any point in time you can state what the contract was, and what issues, problems or correspondence was shared.See contract Management April 6, 2011

19.Manage performance by both companies. The supplier in meeting their committed obligations, and the Buyer’s team in meeting theirs.See contract Management April 6, 2011

20.Manage all changes so they are clear and so they describe what the change applies to. Write them so they don’t materially modify or waive a needed right or requirement for all items. See Amendments April 11, 2011, Amendments, Addendums and Change Orders July 7, 2011

21.Do a self audit of the contract to ensure that:
a.There is a contract. See Legal Requirements for a Contract December 13, 2011
b.It is enforceable and cannot be voided for any reason. See Contract Problems - The Legal Thought Process April 5, 2011, Enforceability December 10, 2010, and Enforceability Costs March 22, 2011
c.That the contract was written with a supplier entity that has the assets or resources to stand behind the commitments or there is a company guarantee in place. See Parent,Company Guarantees January 30, 2011

Monday, August 29, 2011


To manage the life cycle cost of equipment or a repairable /serviceable product, the best time to address the unique issues associated with that is at the time of the initial purchase.If you were buying a product for resale to your customers and need to support that product in the future its critical that you address a number of service related issues whether you will be purchasing maintenance services from them or will be performing maintenance and repair for the customers. Here are a few key points you would address

The term of availability can be how long the supplier is committed to selling maintenances services to you or it may be how long the supplier will agree to make the spare parts or repairs available for purchase. If you purchase the suppliers product for use in your product you normally would want the term of availability to be either the useful life of the product or as long as you have committed to your customers that you will support and maintain the product.

If a supplier is unwilling to provide a guaranteed time period for availability and you still need them, one way to deal with the issue if you are buying standard product is to require them to commit to providing them to you as long as they provide them to their other customers. Many times a Supplier may want to discontinue providing it because the volumes are low. If you need to be able to support the equipment you purchased or need to be able to support your customer you may need to do self repair, self maintenance of need to have that performed by a third party. If you allow the supplier to discontinue the activity there are several things that you need that should be included in your agreement. First you need a requirement of advance notice of the discontinuance so that you can adequately plan for the transition. Second you should have the right to make a last time buy for everything that will be necessary to do the work. Third, you want that right conditioned upon the supplier granting you a royalty-free, non-exclusive, worldwide license to make, have made, use, repair, have repaired, sell or otherwise dispose of the spares or repairs and furnish you with all necessary documentation, specifications, drawings and other data, including its sources for such all repairs, spares and spares components. If the items are proprietary to the supplier you also need to have the supplier authorize the purchase of those items from their suppliers.

Having all the commitments listed in the above section won’t do you any good if you also don’t have a method in your agreement where you are able to control the price.Without that control, the supplier could price the items so that it would be price prohibitive for you to purchase them and effectively avoid the commitment. Suppliers aren’t going to be willing to fix a price over a long term and it they will you probably are paying too much. There are a number of ways that you can build price protection into the agreement. One way is to link it to what other customer pay so you get the best price for those purchase as between all their customers. A second way is to have a price that is based on a percentage off their list price. One of the best ways is to negotiate the prices against the current costs, and then agree to adjust the prices based upon changes in a standard index based upon where the work will be performed. For example for the United States you could limit the amount of any changes to changes in
the Producer Price Index (PPI) for Industrial Commodities (Table 3), for the previous twelve months.

When you return buyer owned material to a supplier for repair, what you are technically doing is bailing the goods to them. As such you need to include the typical protections that you would include in a bailment.You identify them as owned by you in the accompanying Shipping and Billing Authorization Form.You state that you will retain title to all such items, unless the Supplier provides a replacement. In a replacement situation title to the replacement and title to the original should transfer simultaneously. You would own the replacement and the supplier would the own the original.You require that while the buyer-owned material is in their custody and under their control the Supplier must insure them at their expense in the amount of their full replacement value against all risks of physical loss. You require that the Seller shall keep your items separate and identified as Buyer-owned and require that use such items be solely per the terms. This is to prevent their re-selling them and to allow you to recover them if the Supplier ever went bankrupt.Lastly you want the right to demand return of the items if necessary.

An advance swap program is when the Buyer identifies an item is defective and there is agreement that the Supplier will immediately send a replacement out of their inventory so the buyer has a working item usually the next day rather than have to wait for the normal repair process to take place. You would consider an advance swap program when the length of any down time is critical and it may not be economically feasible to inventory items at all locations where it is used. In an advance swap situation the supplier would establish an inventory of known good products that could be shipped immediately and they place the item that is returned back into that inventory once it has been repaired. An advance swap program could be at a product level for items that are small and light enough to be shipped overnight or it could be at a sub-level referred to as a field replaceable unit (FRU) where the defective item could be swapped out at the site. In a advance swap situation, the supplier will own the material that was advance swapped until buyer either meets the conditions of the advance swap or makes payment for the item. The risk of loss for any advance swap would be determine by the delivery terms agreed. Advance swap programs could be done for either in warranty or out of warranty programs. In an advance swap for a product under warranty, as long as the warranty wasn’t voided, the ownership to the returned item would belong to the supplier upon receipt. If the warranty was voided, the Buyer would still own the item and would also owe the supplier for the cost of the replacement. In an out of warranty situation, since there was no warranty in effect, the Supplier would own the material subject to two conditions being met. The item would need to be repairable and the buyer would need to pay the agreed out of warranty repair cost. If the item wasn’t repairable the buyer would still own the material and would also be obligated to pay the supplier for the full value of the repaired item.

In negotiating spare parts and repairs you may need to negotiate two different lead-times. One lead-time would be for standard orders that require standard replacement times. The other for emergency orders from supplier stocking hubs. The contract may identify a specific quantity that the supplier agrees to hold for emergencies and the buyer will usually pay a premium for those items to cover the cost of inventory. Once an item items is consumed the supplier will usually have normal lead-time to replenish those back into the inventory. Once the inventory is exhausted the supplier may, but usually is not obligated to provide replacements until the stock is replenished. As needs change and because the buyer normally will have liability to purchase the stock held for them, the buyer may need to frequently adjust the level of any emergency inventory being held. Where that is most important is when the item is custom or unique to the buyer where there is no other potential customers.

When you need spare parts and repairs for the long term you also need to manage any changes the supplier can make to those items. If changes cannot be prevented in the contract then you need additional terms to protect you. One approach is if the supplier makes a change in form, fit, or function to the spare parts or repairs that, in buyer's opinion, adversely affects they buyers ability to maintain, support, and repair the supplier's products, then supplier would be deemed to have discontinued availability of the spares and repairs and you would want the same rights that you would have for an actual discontinuance that are listed above. If the buyer agrees to such changes you will want all documentation needed to install the changes and shall make all necessary parts available to Buyer at reasonable prices that are no more than what they sell those to their other customers..

In purchasing spare parts or repairs in addition to any of your standard requirements for packaging or packing, you may have a number of additional concerns. Instead of an items being provided in bulk packaging like you would use for production shipments you normally want the items packed to the lowest possible level so it can be inventories and stored in spare parts or repaired parts inventories. You also want the outside of the package to identify a number of things like the part number, qualtity, date, etc.. That’s because you want the contents to be easily identified for inventory and stocking and you want the date so that inventory can be managed on a first in first out (FIFO) basis so you take full advantage of the warranties and for items that have a shelf life make sure they are used within their shelf life. For items that could be damaged by handling such as electronic components you also want the item to be protected against that potential damage. An example of that is electro-static discharge (ESD) where an individual that isn’t properly grounded touches the item and sends a static electronic shock to the item and causes damage. For that you would want the item protected by being packed in an ESD protected back and then packed.

If you want or will need to do self- maintenances you will need to get the supplier’s manuals, schematics, course materials, and literature. If you have many locations and many people that will need to perform the maintenance, you want the right to use, make copies of, take extracts from all of those documents to provide training. All those materials will be copyrighted by the supplier so without being granted the rights, every time you needed a copy or want to make a change you would need to get approval from the supplier.

If the plan is to perform self maintenance and the supplier will support that there are a number of things you would need.Copies of the supplier’s current spare parts price list and updates as they are issued to any of its other customers.A price list covering all tools having an industry standard number or manufacturer's number which are used to test or service the Spares.Ability to purchase any tool not having an industry standard number that are required to test or service the spare parts and their lead time for its shipment.A list of electronic and mechanical components of spares with a) industry standard designations; b) sizes where applicable (e.g. nuts, bolts, etc.); c) manufacturer's numbers for all component parts.A list of recommended spares parts. An illustrated parts breakdown Line drawings and/or assembly drawings for any spare parts not shown in the illustrated parts breakdown.An operator's guide with fault correction instructions keyed to fault indicator.A maintenance guide including installation instructions and preventive maintenance instructions.A print Set with drawings, logic diagrams, schematic diagrams, layouts, block diagrams, flow charts and software listings.

If needed the buyer may require the supplier to provide buyer personnel with training. The usual issues for training are:The number of classes for buyer personnel and cost The location(s) for the training. The number of attendees allowed for each class.The requirements for instructors, all course equipment, course modules, course materials, and training manuals.The scope of the training to be performed. The student to equipment ratio allowed for any hands-on training.
Rights to videotape classes for training purposes.

If the buyer, after the term of availability, needs to perform repair the contract would also include: The supplier must grant the buyer the right to repair or have repaired the spare parts, material and equipment.This would not be required for repairs to your own equipment.The supplier needs to provide the buyer with:A list of components and supplier approved suppliers for those components. For parts that are not available to Buyer from sources other than Seller are to be listed and unit prices identified with quantity discounts, if any. Parts having generic industry identification need to be cross-referenced from any supplier part number to generic part numbers. Available test specifications and test procedures and drawings required for testing.Full description, manufacturer's model numbers of the test equipment.

Thursday, August 25, 2011

Purchase Order Types and Acceptance

There are many types of purchase orders. There are stand alone orders and there are purchase orders that are issued under an existing agreement. Stand alone purchase orders are an offer by the buyer that requires acceptance by the Supplier to create a binding agreement. Acceptance can be done in writing or by performing. Acceptance with different terms creates a counter offer.

Purchase orders issued under a master agreement can be individual or blanket orders. Individual orders are used to make commitments. Blanket orders traditionally provide funding where ordering and commitments may be performed in another manner such as pulling supplier owned inventory from stock.

Whether a PO issued under an agreement is binding or not on the supplier will depend upon what the agreement says. If the agreement said that the Supplier agrees to accept all Purchase Orders that conform with the terms of the agreement and the PO issued conforms, those PO's would be a binding. If the agreement was silent about acceptance of conforming PO's, the PO would require acceptance by the supplier before becoming binding.

If you go through all the trouble of negotiating a master agreement with a Supplier don’t you want to be assured that they will accept all PO's that fall within those agreed parameters.
I never want to have the Supplier have the unilateral right of deciding when they will perform and when they won't. You can’t manage supply chains or production if you do.

Most of the time suppliers won’t agree to accept all orders that you issue unless the commitment includes specific parameters. The most common parameters are:
1. Limiting the scope of what you can order. This is usually limited to only the product or service contemplated by the agreement.
2. They will want to limit or exclude any potential additional of different terms from being included and want to make those terms either void or require their acceptance.
3. They will want to limit the volume of what you can order. This may be a specific amount or a parameter that is tied to a forecast or past orders. The reality is they may have limited capacity and may need to manage the orders to that available capacity and do not want to be potentially liable for failing to deliver should your order exceed that capacity. Alternatively they may not want to assume the additional costs to increase their capacity such as paying for overtime as that wasn't included in the price they agreed.
4. They will usually want to limit the amount you may order when there are shortages or allocations and may offer to provide pro-rata commitments based on parameters like your percent of the total orders prior to the shortage.

The only time where it isn’t reasonable for a supplier to want to place a limit on the amount you can order and that they must deliver is when the Supplier has notified you of an end of life for a product or service and you need to make a last time buy.

Why would you want to have the supplier be obligated to accept the orders even with all these conditions or parameters? The simple answer is some is always better than none and when you know you will be limited you can plan for it.The second reason is without that obligation suppliers will tend to focus their capacity on either whether they make the most profit or on their most favored customers. If you don’t fall into either one of those categories and you don’t have the commitment that they must accept your orders, you may not get product or you may get it late.

Suppliers don’t have a faucets that they can turn of and on when the need more supply. They have extensive supply chains.If a preferred customer fails to forecast and order their requirements and they go back to the supplier for help, where do you think they Supplier finds product for them? They usually take it from other customers they can take it from without liability and ship to those customers later.

Wednesday, August 24, 2011

Novating a Contract or Purchase Order

In the April 11, 2011 post I talk about the general concepts of assignment and novation. Novation is an activity that excuses an original party to the agreement from future performance obligations.

To actually do a novation you would normally write what is called an assignment, assumption and novation agreement letter that is signed by the three parties involved.For example, if you made an early purchase and did a contract or PO with a Supplier and then wanted to assign and novate that agreement to contractor there would be three parties, you, the supplier and the contractor.

An assignment, assumption and novation agreement would normally include a recitals section that describes what you are assigning and why to show the intent of the parties. It then needs to do three additional things.

You include language that exercises your right to assign agreement or PO to the contractor.Under an assignment you would still remain secondarily liable under that assigned agreement if it isn't novated.To avoid that liability you then include the novation portion where the supplier acknowledges the assignment and agrees that the contract is being assigned and novated to the contractor and that only the contractor will be responsible for performance under that contract in the future, Then to close it, you include language where the party to which the agreement is being assigned (in our example the Contractor) where the Contractor agrees to accept the assignment and assume the responsibility for the full performance of the agreement

If you expect of plan on having to do assignments and novations, in both agreements (using my example the Supplier and Contractor) you need to include those rights otherwise it would be subject to their agreeing to them. In the Supplier's agreement you should include the right to assign the agreement and have it novated (usually subject to some reasonable creditworthiness standard) to a third party. In the contractors agreement you should provide them with advance notice of the contracts that you may assign and novate to them and have them agree that they will accept those assigned and novated contracts or P.O.'s and manage them as their own.

The agreement is then signed by the three parties.

In jurisdictions like New York for there to be a novation it must specifically state that it is a novation.

Assignments and novations are frequently used in construction contracting or any other area where fast tracking programs requires a lot of advance contracts and orders and then requires assigning them.

I also used them frequently in divestitures where I needed to assign contracts and didn't want to have any liability going forward. If you are on the receiving end of an assignment and novation agreement (as happens when companies spin off businesses or sell business to third parties) always make sure that the new party has the assets and resources to meet all the obligations. I've had suppliers want to assign and novate agreement to companies that I had concern about and would refuse to accept the novation aspect. So that it didn't affect my supply
I would go to the new supplier and suggest that we create a duplicate of the current agreement and sign that. In doing that the original company would still be responsible for all liability for purchases we made from them and we only needed to look to the new company for protection for what we purchased from them going forward.

Most company law departments have standard templates that should be used.

Frustration of a contract

Frustration is one of the events that excuses performance under a contract.Other events include things such as subsequently illegality, impossibility of performance, impracticability of performance, rescission, novation and lapse of the contract.

The event of frustration is unforeseen and uncontrollable and makes it impossible for one of the parties to fulfill their commitment.The party that is frustrated in their performance of the contract may rescind the the contract and not perform without any liability.

Examples of frustration could be a number of things: destruction of the goods prior to purchase; damage to premises before work was scheduled to perform; intervention by public authorities that would prevent the work to be done; rulings by government authorities that would prevent the work being performed.The key is the event must be unforeseen and uncontrollable.

If a party failed to allow access to the work or failed to provide items they were required to provide during the agreement making the suppliers work be unable to be performed, the supplier would argue that their performance was deliberately prevented by the Buyer. Those types of acts would not allow the Supplier to rescind the contract and be excused of performance. Since the owner or buyer failed to meet their obligations and in effect breached the contract, the supplier could sue the supplier for breach to recover any damages they sustained.

Checking the Group's Productivity

To add value you need to also focus on making sure that the function is as productive as it can be given the number of cost drivers you must deal with. The first step in the analysis is to look inward in conjunction with your customers/.

Is the group’s focus correct (Are we doing the right things ?)
What is the department’s purpose?
Who are the customers and suppliers?
What are the customer’s requirements?
How are we doing in meeting their requirements?
Do we have any fiduciary requirements to the company?
How are we doing in meeting those requirements?
Are we doing things not required by the customers or our fiduciary responsibility?

The next part of self evaluation is to look at the work:

Are we doing the work right?
What are our priorities?
What are the problems and the root causes?
What is the best available solution for the problem? (Short term, Intermediate Term, Long Term)
If we do the fix, will it eliminate the customer’s problem?
Have we prevented the problem from recurring?
What are our other priorities which need to be attacked?
If you have problems a six-sigma appRoach should be used to understand and correct them.

Next you focus on what you could be doing better

Continuous improvement
How can we operate more efficiently ?
What are the priorities for improvements ?

The better you understand the businesses you support the more efficient you will be so take the time to understand the business and their needs and priorities..

Understanding the business
How is the business / Function organized?
Who are the key players in the Business / Function?
Who makes the decisions?
What is relationship been between purchasing and the business/function?
What is the standard procurement cycle for the business/function?
What are the unique risks with the business / function?
Where does the business / function see as opportunities?

Next look at the processes you have.
What is the existing Supplier Qualification Process?
What is the existing Product / Service Qualification Process?
Who makes up the Procurement / Acquisition “Team”?
What are the team members current respective roles and responsibilities?
What starts the qualification or purchasing process?
What completes the process?
What are the existing process “Flows”?
What Contracts are used to support the Business / Function?
What are the Sales documents used for the business / Function?.
a. What do we promise our customers?
b. What do we exclude or limit?
What contract administration is performed
What Scheduling or Program Management tools are used?
What are the channels for communication exist?
What are the sourcing guidelines?
Where is data shared and how is it provided?
How is Supplier Management conducted?
How is Commodity Management conducted?
How are key suppliers and strategic relationships managed ?
What cost reduction efforts have been accomplished ?
What revenue enhancement efforts have been accomplished ?
What portions of the business are centralized ?
What training exists and how is it delivered ?
What is the existing supply base and character ?
What Metrics measure goodness of the Procurement function ?
What are the Metrics the Business is measured against ?
What unique tools, forms, etc. exist
Are there any Unique Policies and Procedures ?
What is size of the Business / Function and their future trends ?
What are the current business plans ?
What are the known problem areas and most recent audit results
What authority has been delegated ?
What unique internal controls have been required ?
What responsibility is retained for delegated work ?
What systems exist ?
Are all the processes and flows documented?

For each point you look at what you are doing, why you are doing it and the extent of the activity, You look at the value added it provides to see if you can eliminate or reduce low value added activities..Keys to look for in this are:
1. Wasteful activities
2. Amount of time spent controlling and checking to value added
3. Large numbers of exceptions, special cases.
4. Substantial redundant data, re-keying of data type activities.
5. No responsible party for the process.
6. Lack of understanding on “why it’s done”
7. Lack of understanding who uses the information.

Once you understand the problems then its time to focus on how to improve the work

Approaches to work improvements.
There are a number of approaches that can be used to drive improvement:
* Time management. How much time does it take to perform the activity.
* Categorize purchases, suppliers and customers by A,B,C analysis. The start with AAA priorities and work downward.
* Identify Improvement Metrics (Suppliers reductions, savings, quality improvement goals)
* Implement quality improvement programs such as Six Sigma.
* Implement cost improvement programs
* Implement leadtime, flexibility, delivery, JIT programs
* Perform Activity Based Costing analysis of activities.
a. Understand what activities your people spend their time on
b. Understand how much time they spend on each
c. Understand the cost of each activity, the value added and the opportunity for change or savings.

Another approach to work improvement is re-engineering the activities performed
Identify existing process and activities
Identify if processes provide added value.
Identify items that could potentially be eliminated or reduced (duplicate activity)
Identify items that could be automated.
For value added items,identify whether they must be done by the group versus done by others.
Involve customers in decisions and priorities
Seek to eliminate no value added activities.
Reduce, re-design activities where purchasing adds unique value.
Transfer value added work not requiring purchasing expertise when they can be done with less cost and the same quality elsewhere.
Provide customers with on-going impact of the value added provided by Purchasing.

A final approaches to improvement is benchmarking and competitive analysis..
Perform Benchmarking (cost and process) / Competitive Analysis by activity.

Focus on best in class companies. Look at dimensions of the business to understand any differences.
Understand the practices they use that lead to their superior performance..
Understand your own processes and practices to see if your practices can be changed or improved to the best in class approach..
Set directions, goals and objectives for improvement..

Competitive analysis:
Focus on the competition. Seek broad range of information. Determine capabilities. Understand your own capabilities. Define strategies and tactics to compete. Understand your own processes. Define your own performance levels. Understand best supporting practices. Set directions, goals, strategies and tactics to compete. If you are concerned about the potential of the function being outsourced, look at the outsource suppliers to see what they do and how they do it to identify areas for improvement..

As you can't do everything immediately, you need to establish priorities for improvement.Understand what the most critical success factors are for the business you support and for your group. Then determine how well you are managing against them. For example how are you doing in terms of cost management, pipeline and inventory management, sourcing and managing key suppliers, risk management, organizational empowerment, skills development, internal controls and performance management.

Tuesday, August 23, 2011

Understanding cost drivers as part of improving productivity

Productivity has a huge impact on negotiations as it impacts the amount of time you can spend preparing for the negotiation. The frequency and number of negotiations required also impacts individual negotiations in the same manner. In both procurement and contract functions a frequent question is "how do we provide more value to company?

My opinion is there are two interim steps before you can focus on providing value and both of they provide value on their own. The first is to understand what I call "cost drivers" that add cost or complexity to the work and your productivity and work with the business to change those.
The second step is to focus on improving your functions productivity, as the more productive you are,the more time you have to add value or do better negotiations. You can't add value when you are constantly in crisis mode. Your aren't going to do the best negotiations when you simply don't have the time to effectively manage the process and prepare for the negotiation.

This post focuses on understanding the "cost drivers". .

There are a number of “cost drivers” that affect the amount and complexity of the support required from procurement and contracts group and the cost to the company.“Cost drivers” can broken down into four categories:
1. There are cost drivers that you traditionally have no influence over that directly impact you.
2. There are cost drivers that you should seek to influence where the final decision is made by another function such as your customer.
3. There are cost drivers that are under your control that may be impacted by other functions and influences.
4. Outside influences that neither your group nor the company can control

There are three distinct approaches to managing cost drivers:
1. Drive those that are totally within your function’s control.
2. Champion and seek to influence those activities that are controlled elsewhere but which drive cost and complexity to your function or the company.
3. Champion the use of suppliers and outsourcing to help drive the company’s competitiveness by reduction of time and cost in non-core businesses that provide the ability to focus investments in key competitive areas.

Purchasing and contracting functions usually have no influence in these decisions, but they directly impact the amount and character of the work and the cost to the business.

Quality of forecasts, plans. This affects number of changes, flexibility to be managed.

Number of products, services and variants supported. This affects the total suppliers, and items purchased.

Product and service life cycles. This affects frequency of change of suppliers, changes in products or services purchases, and number of contracts.

Selling model and sales channels. This affects locations to be supported, level of support required.

Nature of the work and the company’s business goals. This affects the approach to buying, the frequency and complexity of negotiations, and amount of contract management required.

Business metrics, measurement approach and measurement periods. This affects many aspects of procurement and contracting and the priorities that get placed on activities.

Ability of the business of customer to define their needs and requirements. This affects productivity, change frequency, complexity of managing the contract.

Stability of the company (payments, credit) This affects supplier interventions, management responses etc..

Purchasing and the contracting function must regularly try to drive or influence these decisions. The final decisions may be made outside of the function or require agreement with another function(s). These decisions directly impact the amount, character, and cost of the work.

Design re-use. Tis affects the number of suppliers and parts supported.

Custom requirements per product / service. This affects the negotiation, inventory, flexibility, cancellations and the entire supply chain.

Standardization across products or services.This affects number of suppliers and products or services supported)

Number of new suppliers introduced for business or technology needs.This affects time required to develop suppliers.

Character of suppliers introduced. This affects the amount of time spent expediting, and managing performance,problems and contract requirements to help manage them.

Type of good or service to be purchased.This affects ability to consolidate or centralize activities, purchases.

Level of “design value added”.This affects level of purchase, number of suppliers, and parts supported.

Level of “service or manufacturing value added”. This affects level of purchase, suppliers, products and services supported.

Level of “internal value added” to the product logistics. This affects numbers of transactions.

Stability of the work force. This affects general productivity of the function.Locations with high personel turn-over have a huge cost.

Warranty and Service offerings. This affects negotiations, management and support costs, number of low volume transactions, number of supplier and parts managed.

Government programs and degree implementation is committed. This affects the required time to support,and manage at supplier/product/service level..

Production or service delivery strategy (single versus multiple locations) This affects numbers of suppliers, inventory, flexibility requirements, landed costs, etc.

Product lead-time offerings versus inventory/fulfillment strategy. This affects the lead-time, flexibility requirements, management of inventory liabilities.

Flexibility commitments to businesses / customers (wew orders, reschedules). This affects the amount of change with the supply base, need for flexibility or management of liabilities.

Degree of risk or obsolescence with materials. This adds additional need to manage the risks, the contract approach, the negotiation of contract terms, etc.

Approach to suppliers (Competitive or Relationship). This affects the purchasing and contracting processes used and the amount of management required.

Organizational Structure. This affects relationships,cross business activity and the ability to do leveraging for the entire company.

Defined roles related to suppliers. This affects the negotiation process, savings, performance, risks etc.)

Willingness to leverage suppliers complete capabilities. This cAN affect the cost, time to market, number of products of services, suppliers, product development times, etc

Existence of top level strategy as to when and how you use suppliers such as strategic relationships, alliances, portfolio, point solutions. This affects supplier relationships, amount of management required, etc.

Amount of cross business & function involvement.This affects degree of internal coordination, influencing efforts.

Amount of “tops down direction and management” provided and degree of leeway given to dispersed operations.This affects key program implementations, numbers of suppliers, flexibility.

Complexity of required terms in dealing with suppliers. This affects complexity and length of negotiations)

Risk strategy with supplier selection (sole or multiple sourcing). This affects numbers of suppliers, risk and amount of performance management required.

Risk strategy in other areas (e.g. how much risk is passed to suppliers?). This affects complexity and length of negotiations and cost of purchases.

Impact on supplier relationships by others (e.g. Accounts Payable). (affects amount of time spent on supplier interventions)

Amount of dependence on other functions for information, support. (Purchasing - Accounts Payable relationship, systems compatibility) (affects transaction and report processing productivity)

Order/Fulfillment Process and tools (affects degree of involvement in transaction portion of business)

Procurement and the contract management function can and should manage these factors, but they may have strong outside influences in the implementation by other groups.

Required operating procedures. This affects tasks performed and degree of checking, controlling and the amount of value added that is provided.

People knowledge and skill sets..This affects overall productivity, cost. management time etc

Availability of standard tools, systems and information..This affects productivity in transactions, supplier management, commodity management, risk management, reporting and data inquiry.

Number/ versions of systems and compatibility of information. This affects investments in software bridges, ability to have needed information for supplier negotiations, commodity management, risk management and reporting.

Number of standard templates tailored to needs, availability of alternative term needed to manage performance and risk and compatibility of templates with current business models and needs. (affects the amount of tailoring or customization required. If templates don’t reflect needs it can also drive more problems that need to be managed).

These are outside influences that affect Purchasing and are traditionally beyond the control of the business and purchasing but still affect the function .Purchasing and the contracting function must aggressively manage the impact to the business.

Character of marketplace (price volatility, material availability. This affects amount of time required to manage purchases, manage changes, manage suppliers, and the frequency of price negotiations, etc.)

Effect of other influences on product or service availability (e.g. Force Majeure). This affects staff required to deal with service or supply interruptions)

In looking at whether a Procurement or Contract group should be outsourced, one of the key questions to ask is whether the outsource supplier will have all these same cost drivers to deal with or whether the company will make the necessary changes to reduce or eliminate them? If all the cost drivers will be passed on the savings will be limited. If they can change them, why not do it first with your own procurement or contracts group. Their seemingly lack of added value may have been driven by you.

Friday, August 19, 2011

Reverse Auctions

How do reverse auctions tie to contract negotiations? I’ll explain that below.

I’m no expert on reverse auctions so I thought I would post a link to a white paper that SAP posted on their site about reverse auction best practices. They took ten different characteristics of a purchase and then use those to identify the best approach for those characteristics. They describe three different approaches. 1) Using an RFP only, 2) Using a combination RFP and Reverse Auction, and 3) using a Reverse Auction only. Interesting reading:,8,0,125431477,792731079,1313678540,Reverse Auctions SAP,39849994,9029345105&gclid=CJOImvaJ2aoCFQiR5god90kQ9g

To get to my point about how reverse auctions are tied to contract negotiations, the simple answer is that if all you focus on with reverse auctions is price, there is no tie. However if you do a reverse auction where you take into account any differences in life cycle costs, terms or risks the supplier isn’t assuming versus the competition, you now have additional costs in the discussion. Make it clear that they have to overcome those added costs to still be in the race. The message is clear, either adjust their terms so there isn’t a cost or risk differential or they will need to make additional price reductions to offset those costs and risks and stay in the running. If their positions on terms and risks are something that you will never agree to give up for a lower price, let them know that. They are losing the race because of their position on terms and risks versus the competition.That can’t be offset with further price reductions. The only way they can stay in the game is changing their position.

A friend referred to this as his horse race tactic. If you ever have been to a race you know that the announcer is frequently announcing where each stands at certain mileposts. What he would do is make the same announcements so during the process each supplier knew whether they were ahead or behind. While he didn’t share the actual differences, he would be telling the suppliers where they needed to improve to be in the running.

Thursday, August 18, 2011

Personal Data Protection and Liability

A relatively recent issue to procurement is the issue of protection of personal data. Many countries and states rushed to enact laws placing responsibilities on companies that have personal data in their possession that is breached. It is estimated that the cost per breached record is in excess of $200 and the cost of a single breach can be in the millions of dollars.

With these electronic times the question is what procurement contracts need to address data protection. The most obvious is when you are buying a service or have an outsourced contract where the supplier will be receiving, collecting, or holding individual personal data.
The issue of personal data goes well beyond that. I remember reading about a police department that had scrapped or traded in a number of copy machines that they used where significant personal data and information about on-going investigations was stored in the memory of the copiers. Those copiers were about to be resold to the third world markets. In fact any device that stores data could potentially be storing personal data.

As the issue is fairly new one of the most traditional ways of protecting against the financial risk, which is Insurance, has only recently started to offer insurance lines. The issue for insurance is how do they go about understanding and quantifying the risk and potential cost impact. There are also a huge number of companies that sell software to try to protect data against intrusion or copying. The real question is how do you protect against it.

The first time I ran into the issue was when I was negotiating a disk drive agreement. The law department generated new language to be included in agreements to transfer liability to the Supplier. The supplier was adamant about not accepting liability so I found myself in the middle, which seems to a place where I frequently found myself. I have a practical side and decided to look into what we were doing in the past to manage it.

What I found was in our sales terms with our customers we disclaimed any liability for data and instructed them to wipe disks before returning any to us. We would then wipe the disk clean before sending it to the supplier. The supplier, because they could not manage return of the disk to the original customer and wanted to use repaired drives for warranty replacement, had as their first step in their process the requirement to also wipe the disk clean. The problem is that with disks or other forms of memory you can never totally eliminate the information stored, all you can do is try to make it unreadable by writing over it many times.

Another part of the Supplier’s concern was simple. The customer never told us when they returned the disk that it had personal data on it or that they didn’t erase the data. We never looked at what was on the disk either. We just did additional erasing of the disk. So there was not way to advise them that there was in fact personal data still remaining on the disk that required protection. They also didn’t look at what was on the disk so they didn’t know what it contained to be able to manage it differently than their normal process.

Then I thought about how you could provide 100% assurance that it wouldn’t be disclosed.
The only way to completely protect it would have been to totally destroy the disk. That would drive the cost of warranty and the cost of the product up. So that wasn’t practical.

Everyone needs to make their own conclusion, but my opinion for products that can store personal data the prime responsibility for managing against disclosure has to be the owner of that product. Only they know what’s on it. It’s their data, and they should have the primary responsibility to protect it. The best a company can do is to have processes in place to provide some level of protection against those individuals that don’t meet those responsibilities. Both we and the Supplier were doing that.

I also came to the conclusion that where data protection requirements and resulting liability for failing to meet those requirement best fits is when what you are buying a service or outsourced activity that involves the collection, use or storage personal data or when you need to share personal data with a supplier in their performance of their duties. Make sure they are aware that it is personal data and as such it requires a much higher standard of care. Treat it just like how companies share confidential information do because that’s what it is, confidential information if the individual. Then expect them to be liable just like they would be liable if confidential information you provided them wasn’t managed properly. Companies that agree to receive confidential information sign up to that liability every day. Liability for an individual’s personal data should be no different.

Wednesday, August 17, 2011


Like most topics that I write about the view of changes will depend upon whether you are the buyer or supplier and what you are procuring and where you sit in the world. For example in the UK and in other locations that follow the UK approach to construction contracting instead of calling them changes they are called variations.

Manufacturers of products want to be able to make any changes they want as long as the change does not change the form, fit or function of the product. In my March 16, 2011 post I discussed the perils of that and why production Buyers want to restrict or have approval over any changes.

If you are buying other products or services frequently any change requires a mutual agreement of the parties, or the supplier wants the right to make changes but not have to agree to buyer requested changes. The same usually applies to licensing software, the supplier will want the right to make changes, revisions or enhancements without any approval of the buyer and the buyer may request, but the supplier doesn’t have to agree to the change request.

If you were having a product, service or software developed especially for you, its not uncommon for the buyer to want to have the right to require certain changes as long as they fall within the general scope of the work. That of course is providing that the supplier is compensated for the costs associated with making the changes and the delivery schedule is adjusted to reflect the additional time the change will add to the performance of the work.

There are other activities where during the performance of the work changes may be required, and it’s not practical or cost effective to switch suppliers if they don’t agree or you may simply not have the time to seek agreement in advance and need to order changes. The construction industry is clearly one of those areas where the owner needs to be able to order immediate changes to the work as delays can create a huge amount of work that would need to be demolished and rebuilt according to the changed requirement.

In those situations where you need your contract to provide you that right and you need to address how the contractor will be reimbursed for those changes. In the British system of construction contracting where Quantity Surveyors are used to create detailed bills of materials its easy to determine the cost of the change as it gets measured. The problem with that system is frequently bills of materials are not done for electrical and mechanical systems of the building so changes or variations cannot be measured and you still need a formula or approach for items that don’t appear on the costed bill of materials. What does a clause that allows the owner to direct changes look like? Here’s an example.

1. A change order is a written order to the CONTRACTOR, signed by the OWNER, authorizing a change in the Work, the Contract Price or the final completion date.
2. The OWNER, without invalidating the Contract Documents, may issue orders making changes by altering, adding to, or deducting from the Scope of Work.A change in the Scope of Work may also necessitate an adjustment in the Contract Price or the final completion date. No change in the Scope of Work shall proceed and no claim for additional monies for such change or for any extra work, so-called, will be valid unless such work is done pursuant to a written order from the OWNER to the CONTRACTOR signed by an OWNER Representative. Advance approval is not necessary for extra work required to protect life or property under emergency conditions. The OWNER shall determine in each case whether the work done without written approval was of an emergency nature and whether it is to be reimbursed and a Change Order issued.
3. The cost of work for any change order shall be either a lump-sum agreed to by the OWNER or actual costs and a percentage fee for overhead and profit. Such percentage fee shall not exceed fifteen (15%) percent of actual costs for work performed by a CONTRACTOR alone. For work performed by a Subcontractor, the cost to the OWNER shall be determined by a lump sum agreed to by all parties or the actual costs to the Subcontractor, plus a percentage fee not to exceed ten (10%) percent for the Subcontractor's overhead and profit, plus a fee not exceed five (5%) percent for the CONTRACTOR'S overhead and profit.
4. If deductions are ordered, a credit shall be computed on the same basis as increases for extra work.

Note: the approach that allows either a lump-sum mutually agreed or actual cost plus a fixed percent is to try to influence the contractor to come in with a reasonable, realistic lump sum in the first place. If they don't they know they will have to prove their actual costs.

As changes are different between different types of purchases, terminology is different. In construction a Change Order has a specific meaning, It means they are ordered or directed by the Owner. In other areas the term “change order” is frequently used to refer to changes that are mutually agreed instead of directed.

Managing construction procurement:

Here are a few tips on successfully managing construction procurement and contracts.
1. Make sure that you hire the right Architect/Engineer or Engineer/Architect for the work and make sure they commit to a design team that you know will be successful. Having the right expertise for the type of construction you want built goes a long way towards success. Hiring someone that doesn’t or will learn at your expense always causes problems and adds to your cost.

Spend as much time as you can pre-qualifying contractors to make sure that
the Contractor, Contractors Office that will support the work and team that will be managing the work have both the experience and tools needed for the work. Offices in different locations can have different expertise and you want one that has the type of expertise you need.

See blogs on supplier qualification (August 8, 2011) and Supplier Surveys (August 12, 2011)

With both Contractors and Architects or Engineers the people you meet in the
interview you may never see again. Make sure that you identify and interview the actual team. If they or an individual on the team will be key to success, require your approval for any changes to the team. I always recommend that any internal individuals that need to work with the design team be part of that interview and that the design team be part of the contractor interviews. As a team they need to be able to work together.

See blog on interviewing (April 8, 2011)

4. Make sure that you have approval over all subcontractors and equipment
suppliers and weed out any bad apples. Just like any supply chain is only as strong as its weakest link, the same applies to construction. If you have one subcontractor not perform, it will interrupt the natural flow of the construction process as other subcontractors are dependent upon them to complete so they can commence their work. To manage against potential problem, prior to providing their bid you can have the potential contractors provide a list of subcontractors they want to use and advise them in advance if there are any that you object to and don't want bids from. Once it gets to the point where a party has actually bid on the work is when problems can arise. Subcontractors can claim that it was their bid that was used and they should get the work. If the contractor never invites them to bid or if they receive an unsolicited bid and they don't open it, that will usually eliminate the problem.

5. Use the right contracting approach for both the schedule you have and the
resources you have available to manage the activity and the risk you are prepared to assume. Each approach / strategy has different advantages and disadvantages. You can mix or switch strategies during the term of the project especially if you want to fast track a program. Each approach has different risks and management efforts required.

See the blog Contracting approaches (July 2, 2011)

6. Include terms in the contract to both drive the desired performance and have the tools you need to manage performance.

See blog on Managing Supplier Performance (February 25, 2011)

7.Have a good changes provision to deal with all the changes that will incur. As
changes in construction are more frequent the approach to changes is different. Unlike other forms of procurement where changes require mutual agreement between the parties, in construction both parties may request changes, but only the Buyer may order changes to occur. To do that you need a changes provision that identifies both the scope of the changes that you may order and a pre-agreed method to determine both the cost and schedule impact of those ordered changes. Cost is usually managed by a simple formula where the buyer agrees to reimburse the contractor that actual costs of the change (that the Supplier must prove) along with pre-agreed percentage contributions for overhead and profit. Changes will also address how deducts from the work will be calculated.For some work the Buyer may also have the supplier bid per unit costs for a variety of common items that could be changed which could also be used in calculating the cost of changes.

See blog on Changes also posted today.

Perform contract administration through out the work either directly or by using
3rd parties to ensure the contractors are performing to the specification. Don't rely only on the A/E or E/A as they may want to cover up their errors.

8. Maintain an excellent contract file with all documentation on amendments, changes to the drawings and specifications and when they were effective. Make sure a record copy of the drawings and specifications is being updated. Include all correspondence from your people, contractors, subcontractors, architects and third parties hired by you so you know at each point in time what the agreement was, and who did in preparation for potential claims / counterclaims.

See the blog Contract Administration / Contract Management (April 6, 2011)

If you need to fast track a program which happens frequently you can't do
things serially and may need to do advance procurement of long lead items and later assign those contracts to the Contractor. If you do, assign and novate those contracts to the contractor when they are hired.

See the blog on Assignment and Novation (April 11, 2011)

If you need enforce terms in the future primarily with a subcontractor, require
the Contractor to name you as a third party beneficiary in their contract with the

See the blog on Third Party Beneficiary (December 19, 2010)

11. Avoid interfering with the contractor / subcontractor relationship. Once the contract is in place the contractor should have total control over the subcontractors.

Tuesday, August 16, 2011

Supplier Rebates

In a consumer purchase setting supplier rebates are intended to generate the sale. Most companies know that the number of rebates that are actually applied for and that meet the conditions of the rebate are small so it’s a low cost way to try to drive purchases and capture business from your competitors.

In procurement rebates are viewed in a number of ways. Some suppliers consider them hassles and don’t want to invest the time and expense to manage them. Other suppliers will view them as a mechanism to drive future sales and loyalty. If the customer purchases elsewhere, they lose that counting either meeting the conditions of the rebate or they lose rebate. Some buyers view rebates as price reductions that they should have been receiving from the beginning and an additional cost as the Supplier has the use of the Buyer’s money until they pay the rebate.

However you look at it, rebates are clearly used by suppliers with the intent of influencing your future sourcing decisions. For each purchase it can force you to weigh any difference in a competitor’s price against the impact that purchase would have on the rebate, qualifying for the rebate or the price with the rebate included. Many times buyers may drive suppliers to using the route of rebates. If a Buyer wants the one-thousand unit price for a quantity one and makes no firm commitments to purchase more, the supplier can either say no or they can tell the buyer that they will rebate them the difference once they have met that quantity. In doing that they have nothing to lose and everything to gain. If the buyer fails to purchase the quantity for the rebate, it costs them nothing. If the buyer purchases the quantity the only thing the Supplier pays the buyer is the difference and in the interim they have had free use of the buyer’s money.

With companies whose procurement groups are heavily focused on cost reduction, Suppliers use rebates as a tool to lock the buyers in. If they continue to buy from the supplier they will get the rebate that they can claim as cost savings. If they change suppliers, they may get a lesser price on that purchase and can claim that as savings, but they may lose the rebate and they lose the claim of cost savings from the rebate, which may be larger.

Most rebates are tied to volume and in negotiating a rebate you would negotiate it the same way you would negotiate any volume pricing. Look at where there are real cost differences and opportunities at the volumes. Look at their total volume to see what if any real impact your volumes will be. If they get real cost breaks from your volumes the rebate you negotiate should be higher than if your volume will have zero impact on their costs. If your volume doesn’t have an impact on their cost you know that they can sell it to you for the higher volume price without it impacting them at all. I would use that to try to drive the price down. If they won’t agree to reduce the price and only will agree to a rebate approach you need to understand that the rebate is an attempt to lock you in for the future. As the market changes over time you will have that as an additional thing to consider in your sourcing decision or how you split your awards. In the end chasing rebates could have you wind up paying more than what the competition is charging in the future just to get the volume for the rebate. That may have been what the Supplier’s strategy was in the first place by offering it.

Monday, August 15, 2011

Impact of Product Design on the Supply Chain.

Product design has a huge number of things that it will influence as part of the supply chain.

Product design will always influence the cost of the product itself.

Product design can influence your ability and cost to service and support the product. Design drives the “Mean Time To Repair” which is the average time it takes to perform repairs. That will impact either your cost to repair it or it will impact what the supplier includes in their warranty reserve which impact the cost of the product. It will also impact what the supplier will charge for out of warranty repairs or maintenance.

Product design will influence whether you can do self repair or self maintenance or need to use the supplier. That impacts the cost of repair or maintenance on the Supply.

Product design drives the reliability of the product. The “Mean Time Between Failures” or MBTF or FITS will impact the frequency in which repair of replacement of the product will be required. That impacts your life cycle costs and investment you need to make for things like spare parts, replacement products etc.

Product design can influence your ability to manufacture a product in high volume and in a quality manner. This impact the cost to manufacture the product. the cost of re-work, the cost of scrap, the amount of inventory of raw materials, components or assemblies you need to carry to meet the needed output.

Product design can impacts your ability to change suppliers quickly and inexpensively to deal with supplier performance problems or shortages as part of Supply chain flexibility and meeting needed output.

Once your design locks you into using a supplier's product from a perspective of form, fit, or function into your design, it makes changing suppliers more costly and difficult. It may require a product redesign or re-layout. This impacts the ability to manage performance of the supply chain and its flexibility.

Designs using custom products will usually increase the supply chain lead time as there aren’t multiple sources or inventories available or being stocked by third parties. It reduces your flexibility, and increases your potential obsolescence costs as those custom items don’t have another customer and once sold the Supplier has no use for them other than in your product.

Product design for things like capital equipment influence other costs in the supply chain such as consumables, labor hours needed to use the product, energy consumption, amount and frequency of training required, amount of consumables used, frequency of service, maintenance or calibration required and the frequency and amount of downtime you will have and all the other factors in the life cycle cost of a product. For equipment that as part of the design of the product includes software that decision can impact the buyers right or cost to make changes to or derivative works of that software. It also can impact the re-sale value of that equipment if the license for the software is not sub-licensable
with the sale of the equipment.

Most Favored Customer Clauses.

In a separate post I discussed best pricing clauses and many times people view most favored customer clauses the same as best pricing clauses and focus only on price. If all you want to focus on is price you should read that April 11, 2011 post where you will see some of the problems with focusing it strictly on pricing.

Most favored customer clauses don’t have to be limited to just pricing in fact they may be more successful if you focus on the total cost of the relationship rather than price.

If you are a student of total cost you will know that there are a large number of factors that can affect the cost of the relationship other than just the price. In my book I focus a chapter on understanding costs in a supplier relationship. Sure there is price, but there is also the issue of what’s included in the price; There are also a large number of things that will drive costs in the relationship, such as: administrative costs; cost of money, time value of money, cost of inventory, obsolescence costs; costs associated with changes;qualification or re-qualification cost; field costs; hidden costs created by third parties; one-time charges; all the factors that make up landed costs; costs driven by lead-time, flexibility and cancellation; packing or packaging cost if billed separately; costs driven by performance; supplier relationship costs; supply chain costs; costs driven by the supplier’s sales model; the costs associated with the terms, risks and costs you assume; even the selling location and the impact of taxes can impact your cost.

If I felt that I was one of the Supplier’s most favored customers I would want to be given the best of all of those things that they commit to their other customers. If they make commitments to improve another most favored customers supplier chain, I want them to offer those same commitments to me. I would want anything that they offer to another customer that reduces their risk or all the life cycle costs of the relationship to be also offered to me. I want the shortest lead time, the best cancellation or reschedule terms, the most flexibility, the best of all the most favored customers. I may not elect to use all that they offer to others, I may want to only use the savings that that customer will get as leverage to have them provide me something better with equal savings.

Friday, August 12, 2011

Common Questions in Supplier Surveys

Understanding the supplier, what they do and how they do it is important not just for making sure that the supplier is qualified, its also important for negotiations. So I though it would be good to share some of the common questions I would ask and explain why,

1. Date – You write the date on any survey as status is time dependent. Ensure information is current.
2. Prepared by: A supplier may have been qualified under a unique set of circumstances or for a specific size or type of work which you won’t know unless you can ask.
3. Street address - There may be multiple suppliers with the same name, or multiple locations for one supplier.
4. Sales/business contact information. This is who they want you to talk to.
5. Engineering contact information. Use these to probe for information about the product, process, which you can use later in the negotiation.
6. Service contact information. Use this to probe for information about warranty, service, returns, which you can use later in the negotiation.
7. Parent company (if any). If you are already doing business with the parent use that to leverage to total business in the negotiation and use what has been agreed as “precedence” in discussions.
8. Subsidiaries (if any). Same as above.
9. Manufacturing locations. If you understand where they manufacture the product you may be able to push fulfillment from the location with the most advantage to you (reduced delivery costs, lead-times, duties, etc.)
10. Service and repair locations. This impacts the response time they can commit to for service and the lead-time for repair/replacement.
11. Years in business. General question, but may lead into discussion of previous names for the company giving a better history.
12. Services and products offered: Understand the total portfolio, for use when trying to consolidate or leverage purchases or to “hold out the carrot” of the promise for future business to negotiate a better deal now.
13. Percentage work done internal versus outsourced. You seek this to understand capabilities and where they may have potential margins built in which you can negotiate. If a large percentage is subcontracted out they may have less margins to work with.
14. Major customers and contacts. Use this information to check references.

Financial Questions
1. Ownership. You look at ownership from a standpoint of leverage you may get from prior relationships and connections.
2. Company Type. Corporation – public – private, limited corporation, partnership, individual. If private, as them to identify the principal owners.
3. Sales: (last five fiscal years. One of the key aspects of sales is understanding how important your business will be to them so you may use that. Sales Breakdown – by geography, percent public versus commercial. Getting a breakdown of sales is key in understanding how important your business will be to them in that segment so you may use that. E.G. If they were primarily government/ military and clearly wanted to expand into commercial your business may be of greater value to them.
4. Services Revenues. In buying you must consider the total cost of ownership and on-going service and maintenance cost may be a large portion of that cost. Negotiate these costs before you buy when you still have the leverage of the purchase or any concessions you negotiate you will probably pay back several times later.
5. Source of sales by percent (Competitive vs Negotiated) : Source of sales indicates what they are familiar with and have most likely priced to. E.G. If they are used to negotiations and you ask them to competitively bid, they may still expect a negotiation to occur after the bid process and price it accordingly. In many places a competitive bid situation is only the preliminary to the negotiations.
6. Bankers. Total available lines of credit, current amount of credit line used. Their cash position will help identify their value of money which is important when discussing payment terms, investments, inventory etc.
7. Financial Reports (last 3 financial years): You review their financial reports from the perspective of insuring that they have sufficient financial strength but also to get an understanding of the types of operating margins they have achieved, their overhead costs, their cost of goods, cost of sales etc., all of which you would use in the negotiation. Get reports with Auditors notes.
8. Growth Plan. An aggressive growth plan, or major capital investment all require a backlog of business to support it. Use that knowledge to your advantage.
9. Substantial litigation in which you are currently involved. You want to understand this from risk factor but also from the leverage you may gain from it. Many companies shy away from doing business with companies who have problems leaving opportunity for those who are prepared to take manageable risks.
10. Assets – property, capital assets, owned versus leased? Assets play a major role in understanding capacity and you would use disclosures to do a sanity check against their stated capacity. Also use them in any discussion on “one time costs” which they would seek to charge.

Percent permanent vs contract, turn-over rates, breakdowns by skills, union vs non-union, dates contracts expire. Employee status is something you would want to understand to determine leverage you may have from any under-utilized capacity they may have. E.g. If they lose the work will they still have to pay their people? Would they take the business at a lower margin to cover their fixed and semi-variable costs?

Facilities / capacity / flexibility, production equipment, manufacturing processes, process controls, tooling, documentation, ECO controls. Looking at these areas help identify capacity, constraints and how well the manufacturing activity is managed. Shifts can be key information in negotiating upward flexibility Capital equipment constraints help identify how capacity much you can have before there is a discussion of additional capital required / who pays the costs / or what commitment is required. Process constraints are looked at from the standpoint of at what volumes will additional process equipment investments be required. Percent of automation will help identify the degree to which the supplier may expect learning curve or process improvements that will reduce their costs.

Percent of material that is consigned, purchased, manufactured by you, made by an affiliated company. If a large percentage is consigned it will usually mean that they will have less leverage to get best pricing in negotiations for you if you want them to do the buying. The more vertically integrated they are or the more materials or services come from affiliated companies, the more you should seek to leverage their pricing as a whole. No one will win unless they all contribute. What percent are single sourced? A single source may mean little leverage unless their is real competition to the suppliers product. Then it can be the message that no one will win unless they all contribute.

Current performance:
Delivery plus zero or minus 1 day at suppliers dock, 100% quality / zero inspection, lead-time less than or equal to actual process time, flexibility to respond to demand, percent cost reduction per year. Make sure that what they represent they can and will do and they are held to it in the agreement.

Supplier Management:
Who are your major suppliers: The quality of the suppliers indicates their commitment to quality, their focus on materials or service costs. What type and percentage of the work is subcontracted? Quality improvement programs, Delivery / lead-time/ flexibility improvement , Cost reduction/value engineering programs, programs for early involvement in design. The extent to what they have any of these as effective programs will indicate the degree of opportunity for cost improvement available. Few programs, not highly effective should mean substantial opportunity to negotiate additional cost improvements whereas if they already have all in place and they are effective, the degree of opportunity is reduced. Programs to prevent interruption of supply? Use this for negotiations to excuse yourself from firm commitments in the event of problems, force majeure situations. Use it to get commitment of multiple locations that you can use for supply chain advantages.

Channels of purchase:
The channel they buy from affects what they pay and your cost It also affects what they can contractually provide. The fewer direct contracts they have with OEM Suppliers the more you need to look at whether they can stand behind the contract commitments on their own.

Sales channels.
What channels do they sell thru? You want to understand if they will deal direct or will want you to purchase through third parties as that can affect both your cost and the value of any contract terms. Understanding that a supplier sells through distribution can provide additional flexibility or sources for materials in the event of shortages.

Organization / Key Personnel, Program Management.
The more the purchase will be dependent upon their personnel the more you want to know: how they are organized; how they manage their people; and programs and tools they use and who will be managing the work for you.

Design resources, design rules, understanding international requirements, design capabilities, design tools - CAD etc, VA/VE activity, special expertise. This looks at the suppliers capabilities should you look to the supplier to develop new products or change existing products.

Quality processes, quality controls – Incoming, in process, tests, reliability programs. These will give you an indication about how well the supplier manages their quality, which can impact you costs of management of quality performance problems.

Service and repair
Services and tasks performed, frequency and duration, Response times for service calls. Cost of service not included in the price. This identifies what you can expect and what some of the life cycle cost will be.

Repair capability, repair quality, repair channels, long term support, training, parts availability, repair cost/turn times and repair locations and programs. This identifies what you can expect and what some of the life cycle cost will be.

What they provide, when they provide it, at what cost, frequency, response times etc. This identifies what you can expect and what some of the life cycle cost will be.

Representative Work (Used in conjunction with reference checks):
When did they do the work? How large was the project? What was their role in the project? Who managed the project for them? What office or group manage it? What Contract Approach was used? What was the frequency of change, change requests or waivers from specification? What was their adherence to the schedule? Were there problems that occurred during the project? How did they respond to them? Where there any claims, or disputes? If they were going to do it over again, what would they do differently? The key in these types of questions is understanding what they did versus what you want them to do. A second key is identifying if they still have the skilled people to repeat the successful performance.

For Software:
1.Operating systems and revision levels supported. Does it work on what you have?
2.Scope of license: Exclusive/non-exclusive & geographic scope? Right to sublicense? Object code & source code OR just object code? Site/CPU/or unrestricted license? Limits on use: internal/3rd party/potential competing uses? Term: time certain OR perpetual? The scope of the license should impact what you are willing to pay. The more restrictive or limited, the less you want to pay.
3.Delivery and Installation: Time frame? Media or delivery method, FOB location; Acceptance, Test: start date and duration criteria: preferably, specifications. Assistance included? Export classification? Buyer or Supplier Installation? You ask these questions to understand what is included in the price.
4.Warranties: Start date & duration, Material errors or failures: criteria? Repair or replace requirements, Time response requirements, Disclaimers. You consider these from a perspective of the value of the purchase and life cycle cost.
5.Documentation. Documents and quantities provided in price? License of documentation: Rights, if any, to prepare derivative works? Rights to copy for internal training? You consider these both from a pricing perspective and life cycle cost. If you constantly need to purchase documentation from them or have them prepare derivative copies the cost adds up.
6.Training. What’s recommended? What’s included in the price? Location, number of students, cost and details of additional training? This is another life cycle cost issue.
7.Consulting services. What is included in the price? Cost of additional? While you may not need them its best to understand what they will do and what it would cost in case you do need them.
8.Maintenance. Maintenance: scope, cost, error correction & response times? Hotlines, escalation processes? Another life cycle cost element relating to either the cost of the service or your cost of downtime.
9.Enhancements: definition of enhancements, scope, cost. The key to this is understanding what you will get under warranty or maintenance contracts versus what they want to charge more for.
10.Future releases: Planned releases, cost of release, how long will they support multiple releases? I always ask this as I might want to delay the purchase and buy the next release or negotiate a free upgrade to that future release as a condition of the purchase.
11.Source Code: Is it provided or escrowed? If escrowed, the escrow agent’s name and location. What are the provisions for release. This is to understand the protection you will have if the supplier fails and is unable to support the product.

For software that is included as part of a piece of capital equipment you want to make sure that you have the right to sublicense it to any purchaser of the equipment. Otherwise it can make you equipment useless or significantly reduce its resale value making the life cycle cost high. You use The impact to life cycle cost to either pay less of get the right to sublicense.

Thursday, August 11, 2011

Industry standard agreements

In many industries there are "industry standard" agreements. For example in the U.S. for purchasing construction there are “standard agreements” published by “AIA” the American Institute of Architects. There are also “standard agreements” published by “AGC” the Association of General Contractors.

Most “standard agreements are produced by associations of suppliers for that industry. I’ve never run into a “standard agreement” that was created by an association of buyers. Since “standard agreements” are produced by supplier associations, it shouldn’t surprise you that their terms favor the supplier rather than the buyer.

While its always best to try to use your agreements, there may be times when you may need to use one of those standard agreements. If you do you should approach it in the same way you would approach using a supplier agreement.

First you read what it says to identify the items you need to delete, amend or supplement to make it acceptable. Second, and this is an equally important step, is you need to read it in conjunction with your standard agreement.The problem with industry standard agreements may not be what it says as much as what it doesn't say.Reviewing it with you agreement helps identify what may be missing or different that you either need to add or change in the standard agreement.

When you use a standard agreement there are two approaches you can use to create the document. The cleanest way from a contract management approach would be to make all deletions, additions or changes within the standard agreement format and prepare that for execution. A second approach is to create a contract that incorporates the terms of the standard agreement by reference. Then you manage all the changes you need to make similar to writing an amendment. For each change you refer to the specific sections of the standard agreement that you want to change and the spell out how that is modified by additions, deletions or change. While this may be a faster approach especially if you don’t have a soft copy of the standard document to edit, from a contract management perspective it forces you to read both documents together to understand the actual commitments. If you do take this approach for speed, you can later generate a restated copy of the Agreement and have that signed replacing the existing document.

For more about the amendment approach see the April 11, 2011 Blog on amendments.

Wednesday, August 10, 2011

Common Cost Accounting Terms Used In Cost Based Negotiations:

In my book I spend several chapters on cost. One chapter explains all the different costs that can exist in a procurement relationship. Another chapter discusses negotiating cost. If you are going to do cost based negotiations you need to be able to speak the language and understand what all of the cost accounting terms mean. Since negotiating cost is one of the key portions of negotiations I wanted to share a list of the most common cost terms.

Actual cost is the actual expenditure for labor and material.

Allocated cost Is the cost of supporting departments that may not be directly attributable to the product or service. Allocated cost is shared by a formula.

Administrative expenses are usually allocated on the basis of total cost of products (i.e. labor plus materials plus manufacturing overhead).

Budgeted cost is based on a budgeted amount that is carried in the estimate.

Capital assets are items that must be depreciated over defined depreciation schedule.

Cost analysis is the review and evaluation of a supplier’s proposed cost or pricing data to determine what the cost should be, assuming reasonable economy of scale and efficiency.

Costs are expenditures for material, labor, and burden (expenses) incurred in the production and sale of an item or service.

Contingencies are not costs, they are reserves (when accounted for) or allowances (when built into the prices) to cover events or situations that may occur, such as possible increases in material prices, lower yields, higher labor costs, or delays in the schedule. When the contingencies occur they result in cost. If the contingency called for never occurs and they were treated as an allowance, they become an addition to the suppliers profit.

Direct costs are those costs that have been incurred and which can be directly traced to a given product or service. Direct costs can be charged directly to that of a given order, job or product or service. The most important direct costs are labor and materials.

Direct labor is the cost of all labor performed upon the product which changes the shape, form, or nature of the materials that are used in the product or service and includes: wages, fringe benefits, payroll taxes, bonuses, and other compensation.

Direct material is the cost of raw materials, purchased parts, and subcontracted manufacturing or services that become part of the manufactured product or service.

Expenses are purchases that may be expensed in the year purchased.

Fixed costs are not affected by production quantity or volume-period costs. Examples of fixed costs are depreciation, rent, and executive salaries.

Incremental costs are the costs to produce more of a unit or product, labor, material, etc. This is an important way to view costs particularly in the pricing of changes in work, material or scope or changes in production quantity or volume. Only the incremental costs should be relevant.

Indirect costs are those that do not result from the manufacture of a specific unit or lot or performance of the service, so that they cannot be charged directly, but must be allocated or apportioned to that product or service by some method of approximation.

Manufacturing or production overhead is indirect expense incurred in the manufacturing, conversion, or service delivery process. Manufacturing or production overhead expenses include Indirect labor, maintenance and operating supplies, and fixed or period charges (i.e. expenses not affected by quantity or volume of production) Among manufacturers, indirect labor would broken down into sub-categories such as production foremen, group leaders, clerks, and production material handlers, quality control and process engineering, procurement, materials and production control, including scheduling, receiving, and warehousing, industrial engineering, supervision, cost accounting and industrial relations. Non-labor expenses in manufacturing overhead include maintenance materials: spare parts, operating and repair materials, work performed by outside maintenance and repair contractors. Operating expenses such as building maintenance, depreciation, all perils insurance, taxes, fuel and non-production fuels and electricity, non-capital equipment and tools. Overhead costs also include expendables, office supplies, postage, rentals, non-production travel, depreciation and amortization, dues, memberships, obsolescence of raw material, and auto expenses.

Material acquisition rate would be a charge applied to the materials cost to cover the associated overhead and expenses that may not be directly attributable to the item. It’s an allocation of costs against each purchase expressed as a percentage of the direct material cost.

Non-manufacturing overhead includes all other indirect costs, such as selling administrative, engineering costs, research and development expenses, sales commissions, travel expenses, advertising, insurance on finished goods, taxes on finished goods, officer's salaries, office personnel salaries office stationery legal and accounting expenses, office supplies, telephone and related expenses, losses on bad accounts, contributions, etc.

Opportunity cost refers to profit that will lost from not taking a particular action.

Overhead costs are indirect costs that cannot be charged directly to a unit of product or service. They may be accounted for in one general account, or may be broken down and allocated against a more direct accountable function or department using an activity measure such as direct labor hours, machine hours or units produced. The approach used for assigning overhead can be extremely important as they can be used to unreasonably burden the cost of a product. Overhead cost and overhead rates can also be actual, expected or budgeted. Suppliers may have manufacturing or production overhead, selling and administrative overhead, and engineering overhead.

Period cost is a cost recognized in the period in which they occur.

Profit is not a cost. Profit is the return on the supplier’s investment for risk-taking, the use of their capital, and for managing production and operating performance. Suppliers profit goals may be calculated different basis depending on the Supplier:
Profit on Sale - Gross margin (GM),
Profit before taxes (PBT)
Profit as a rate of return on assets (ROA)
Rate of return on investment (ROI)
Profit as a percentage of cost
Profit through over-absorption or over-recovery of cost

Product costs are costs assigned to the product produced.

Relevant costs are costs that differ with alternatives.

Reserves are contingent costs that are accounted for to cover the cost of obligations that may occur in the future. For example many companies that offer warranties against defects will establish warranty reserves that are considered part of the cost of the product at the time of sale. Those reserves are used to pay for future warranty costs incurred.

Semi Variable. Semi-variable costs are a combination of variable and fixed. A certain portion is fixed and another portion varies based on the level of production.

Set up or tear down costs are associated with setting up the equipment for production and tearing down the equipment after production has been done. Set up and tear down costs are usually established in standard labor hours to perform the tasks and then should be allocated or spread over the production run.

Standard cost is a predetermined measure of cost based upon time and motion study, past costs and production experience, expected costs, theoretical costs or some combination thereof. Cost accounting systems may employ either actual or standard cost data.

Start up costs can be a hybrid between the variable cost and fixed costs of overhead, which result from a particular activity:
Special engineering from design or production.
Special Tooling - tools, dies fixtures.
Special set up costs such as purchase and installation of special machinery.
Rearrangement of physical manufacturing plant.
Loss of use of facilities during set-up.
Training costs for employees to implement / use new process.
Start-up costs may be accounted for in standard overhead accounts, but as the Buyer you would want them to be segregated. This is to avoid their being treated as recurring costs, rather than one-time or non-recurring expenses. You want to pay for the start up costs once, and not be paying for it over and over as part of some overhead rate.

Sunk cost refers to costs that are already incurred.

Unit costs are costs of a unit of product as incurred cumulatively through the production and/or distribution cycle or delivery of the service.

Variable cost. The cost will vary directly with production quantity or volume. Common variable costs are direct labor and direct materials.

Variances normally apply when standard cost approaches are used. Variances represent the difference between the actual costs you incur versus the standard cost. Variances may be favorable positive where the actual cost is less than the standard cost. A negative variance occurs when the actual cost is more than the standard cost. Suppliers track product cost variances or overhead variances. Buyer’s track purchase price variances.

All costs may be actual, budgeted or standard.