Applying the Value Chain to Cost Analysis

on Thursday, September 24, 2009

The gap between a firm’s costs and their customer’s willingness to pay represents a firm’s competitive advantage and profitability. To increase competitive advantage and profitability a company can either take actions (marketing, design, R&D) to try to increase the customer’s willingness to pay, or they can take actions to reduce costs.

While increasing the customer’s willingness to pay sounds like a simple enough concept, it is much more difficult to accomplish in practice than it is to talk about in theory. The structure of a company’s business model, its position in the market, or available capital and cash flow can seriously restrict a firm’s ability to engage in activities that could potentially increase the customer’s willingness to pay. Even when such resources do exist, there is never a guarantee that a tangible ROI with ever be captured.

For these reasons, many companies choose to focus on reducing cost. A company’s cost’s when properly understood and assessed represent the piece of the competitive advantage equation that can be controlled by the firm to a certain degree. One good method for cost analysis is to examine the costs associated with each step of the firm’s value chain. Below is a generic value chain for a manufacturing firm and the steps a firm should take to apply the value chain to cost analysis:

Sourcing the Value Chain
  • Step 1: Identify the principal activities that make up the value chain.
  • Step 2: Allocate total costs to each function within the value chain.
  • Step 3: Identify cost drivers within each value function.
  • Step 4: Identify linkages. How will a change in one functional area affect another?
  • Step 5: Develop strategies for cost reduction
The nice thing about applying the value chain to cost savings is that it helps keep cost reduction strategies consistent across the organization. When you look at any one of the functions on the above value chain in a vacuum, Goods Inventories for instance, it is easy to develop cost savings strategies that are very effective within that value function but detract from the organizational strategy’s consistency. Obviously any cost savings strategy is going to require trade-offs at different levels of the value chain, but looking at cost savings through a value chain lens can help mangers to make these trade offs in the areas that reduce costs most significantly with the smallest effect on the value added by the function or the organizational strategy as a whole.

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Energy "Management"?

on Wednesday, September 23, 2009

Every time I read an Energy Consumption audit, I snicker at the results/recommendations.

Often packaged in slick power point presentations, or even glossy binders with colored divider tabs, these reviews usually take many pages to present what could be done in a spreadsheet and a few paragraphs. Why; you ask? Because the appearance of value is often as important as the value itself, it seems. This is why personal computers are still about the same size as they were 20 years ago.

In essence, this is what energy audits report:
  1. You saved/spent more money this year vs. last year because it was hotter/cooler this year vs. last year.
  2. You saved money this year because you managed to turn things on and off better this year than last year.
  3. You saved money this year because you installed more efficient/alternative energy using/saving stuff that you didn’t have last year.
  4. You could save more money by using even less energy as demonstrated in B and C.
  5. You could save money by buying your energy on the retail market, where applicable.
That’s about it folks.

Here’s what kills me. These audits, for all the glitz and energy saving glamour, are absent the deeper examination to drive the results home.

For instance:

Just because degree days, year over year, were equal, and the client spent less, doesn’t mean there was an actual savings. Did decreased occupancy play a factor? Did working hour changes create a delta in peak demand? What about interruptions in business . . . ., etc?

Are the same considerations, et al, weighed into the benefits of retrofits, EE equipment, etc?

Further, is the payback clearly defined on recommendations for additional cost savings?

The moral to this story is simple. Beware of facilities maintenance managers bearing savings. Read carefully, and challenge the results not just for accuracy, but for practicality. Almost any facility can save money through better energy management, but let’s make sure it’s more than just a lucky accident.
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Dun & Bradstreet's New Competitor

on Tuesday, September 22, 2009

I stumbled upon an article over at CNET about a new competitor to Dun & Bradstreet's traditional credit rating company. The new company, Cortera, at first glance, has an innovative approach on collecting data through a crowdsourcing model. Cortera is in its early stages, so it has yet to have been proven as a viable alternative to D&B. However, they claim to have a particularly strong user base in the construction market and have recently received $19 million in venture capital.

I ventured over to their site to see what it is all about. My initial impression is that they did a good job of making the site very user friendly, the home page offers a search engine style interface so you can get right to work. Digging around a bit, I found that Cortera does provide some basic information at no cost, such as high-level profile data (key facts) and a payment rating. I found that the key facts seemed to be fairly accurate after a few tests (I would say more accurate than D&B for small business searches). However, I would need a lot more information on the "Cortera Payment Rating" as it does not seem to match with my personal experience on some of the suppliers and companies that I am very familiar with (on how quickly they make payments).

Paid members get a lot more information than key company stats. They are provided with:

  • Key Facts
  • Spending Behavior
  • Shipping Spend
  • Spending Level
  • Payment Rating
  • Current Score
  • Score History
  • Industry Benchmark
  • "Yelp" style reviews (community generated reviews)

I might have to purchase a few reports to see how accurate their spending level and spending behavior reports are, as this could become a great prospecting tool and market research tool for Procurement Service Providers. However, I would guess that they probably simply estimate those expenses based off the estimated revenue for that given company.

For now, Cortera is focusing its efforts on attracting small businesses who cannot afford D&B's traditional pricing model. At $3.00 per report, I think it is a bargain, provided the data is accurate. Cortera thinks they have a shot because they can attract business that normally cannot afford D&B reports. However, the costs for running a site like this can be extreme, especially when it comes to policing the data and reviews that users are submitting. So we will have to see if they are able to pull this off.

Has anyone out there used Cortera yet? Any Feedback?

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Supply Chain Agility

on Monday, September 21, 2009

On September 13th, the New York Times reported that the institute for Supply Management announced an uptick in manufacturing for the first time since the recession. The index rose to 52.9 from an abysmal 33 at year’s end 2008. Is this cause for celebration? Well, like the folks at any auto rental company besides Hertz say; not exactly. But it is cause for encouragement. While we haven’t returned to 2005-2006 levels (mid 50’s), the index reflects a stemming of the rapid deceleration in the manufacturing sector of America’s economy.

While it comes as a surprise to those of us who thought America had discontinued manufacturing completely, the uptick means that many who have been laid off are actually being called back to work, and that inventories that were allowed or even forced to dwindle are being replenished. But keep in mind, this isn’t growth, it’s replenishment. Will there be growth? Speculators are very cautious.

The Times selected Wisconsin as the focus for its examination as Wisconsin has the largest share of its labor pool employed in manufacturing, 17%. That said, Wisconsin’s only real growth hasn’t come from major equipment manufacturers like Rockwell Automation, but rather from Miller Beer. It appears that hard economic times benefit the manufacturers of some products, anyway.

But the slow roll to growth in manufacturing drives a question or two for supply chain managers. For those who rely on companies like Rockwell and other manufacturers; what happens if the bust goes boom, and the usual suspects have cut costs so deeply and delayed improvements for so long, that they can’t flip the switch to full tilt manufacturing? What happens if the new domestic manufacturing sector has constricted so tightly that new cost structures, longer supply cycles and even system transitions become facts of life. Well that would be challenging.

But if the last few years have taught us anything, it’s that those challenges are no longer the exception. So supply chain managers that aren’t already agile, better learn to be agile. If and when growth comes, we don’t caught wondering where our next order will be placed.

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Did Jon & Kate do their homework?

on Wednesday, September 16, 2009

I remember watching an episode of Jon & Kate plus 8 (pre-separation) when they greened out their house in PA. One of the energy saving projects was to install solar panels on their roof. Aside from positioning them exactly to Kate’s liking for visual appeal I hope they did their homework on the type of solar panels purchased.

According to another BusinessWeek’s Green Business article, vendors in only one U.S. state (Florida) have agreed to follow the performance and quality standards set in 1999. Now if Jon and Kate’s house were in Florida or Europe, then the same manufacturer panels would be of better grade. According to TÜV Rheinland PTL, a testing lab, because of this, “manufacturers make two grades of panels: one for the U.S. and another for Europe”.

Let’s hope they thought (or were instructed at least) to ask for quality certifications showing their solar panels passed federal safety tests. Nonetheless, if you are thinking about going green and saving money by installing solar panels for your home or business, be sure to ask the right questions and do your homework!
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Quantum Leap makes a comeback?

on Friday, September 11, 2009

Imagine that! No I’m not really talking about the ‘89-‘93 NBC TV series. Actually, I’m referring to the newest product in energy saving lighting evolution:

incandescent bulb
compact florescent lights (CFL)
light-emitting diodes (LED)
quantum dots!

A startup company in MA, QD Vision, says it can combine LEDs with 5 billionths of a meter wide crystals referred to as quantum dots. This will reduce energy use and improve light quality. BusinessWeek’s Green Business article goes on to say QD Vision and its partner, Nexxus Lighting (NEXS), are coming out with a $100 bulb that uses 12 watts, matches the output of a 75-watt incandescent bulb and can last 50 times longer. Oh boy, am I impressed.
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The Number 9

on Thursday, September 10, 2009

Yesterday, 09/09/09, a big fuss was made over numbers. But, for many of us, it was no different than any other day in which the majority of our decision-making and daily activities revolve around numbers. Pricing structures, discounts, rebates, payment terms, contract years, a projected savings percentage with a new supplier, part numbers, quantities purchased, purchase order numbers and so on are all aspects of Procurement in which numbers play a significant role.

When performing research on a certain commodity, we are normally on the lookout for significant trends, which usually come in number form. When selecting a new supplier, we typically factor in a company’s pricing structure before analyzing the servicing aspects.

After reflecting on how numbers make Procurement go round, I decided to think outside of our niche and reflect on how numbers impact our everyday lives. Just think of all the aspects of your life that depend on numbers: your social security number, credit card number, cell phone number (and landline number), bank account number, income, age, zip code…the list goes on and on. It is difficult to think of aspects of our lives where numbers do not come into play at all. A good conversation? A walk in the park? Listening to some tunes? Reading a novel? Enjoying your favorite meal? If you want to nitpick, numbers have some sort of impact on all of the above, but some nitpicking may be a bit of a stretch. A good conversation could last hours and we could be talking up to 4 hours or 240 minutes or 14,400 seconds. A walk in the park could eventually become a 3-mile walk if you have a pedometer to count. If you’re listening to music, you could be doing so in your car by tuning into Froggy 101. If you’re reading a novel, you may be concentrating on the number of pages you have left until you can move on to the sequel or you picked the book up at the library and used the Dewey Decimal System. And when swallowing that last bite of your favorite meal, you may be thinking about the number of calories you just consumed. It is difficult to escape the existence of numbers because their origins trace back thousands of years.

The world of sports and casinos are where numbers are really all that matters. I won’t dive into specifics here because there are endless examples. Yesterday, Major League Baseball celebrated the number the game revolves around. Video tributes were played to honor two players that wore the number nine, Ted Williams and Roger Maris. Also, select items on MLB.com were reduced to $9.99 to celebrate the date (the special may still be going on). Many individuals may have found themselves at the Roulette table placing their chips on the number nine rather than cheering on their favorite team in the bottom of the ninth inning. Others may have checked out what was playing at the movies, I’ve heard “District 9” is a must-see, and Tim Burton also released his newest animated movie, “9,” to coincide with the special date. As for me, I watched America’s favorite pastime as number 2 tied number 4’s record for 2,721 hits in a Yankees uniform.
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Nix the Quick-Fix? Yes, in most cases.

on Tuesday, September 8, 2009

Quick-fix solutions are similar to band-aids. They are appropriate when we are faced with minor scrapes and bruises that do not take long to heal. How then does a company react when minor scrapes and bruises suddenly become huge gashes and sores in need of some serious bandages? These wounds may be the result of a supply base going out of business or a cost increase in a certain commodity. Whichever may apply, reactions vary among companies as some look for a hasty remedy while others are more interested in an intensive sourcing process that will reap benefits in the long run.

It is normal to prefer using quick-fix solutions for problems that need more than just some Neosporin. I understand that some are acceptable as they alleviate the problem for the time being while a more long-term answer is in the works. The hybrid car, for example, is not the solution to rid the world of harmful gas emissions, but for the time being, these cars are lessening the amount of gas emitted into the atmosphere. We must keep in mind that the bleeding is going to continue and the hybrid car cannot soak it all up (I’ll end my analogy on that note). Hopefully, a global plan will come to fruition in Copenhagen this coming December as national leaders gather for the United Nation’s Climate Change Convention.

The ultimate goal is to eliminate problems, not just postpone them. When a sourcing process is in need of a fix, there is really no such thing as a permanent solution and problems are never really eliminated. The same goes for many other complex entities. Markets constantly change, supply chains are continuously disrupted, and technological shifts occur on a regular basis.

It is easy to fall into laziness mode once a quick-fix solution has been implemented. Procrastination sets in and only when the panic button is hit do you then begin to care again. We need to remember that whether it pertains to strategic sourcing, running a marathon, planting a “recession garden,” or acing a test, there are really no shortcuts that reap benefits. In the end, you are only hurting yourself. You’ll get tricked by suppliers, come in last place, grow rotten veggies, and not learn a single thing.

I’m not saying that quick-fix solutions should be thrown away. I’m just discussing on when they are to be used appropriately. Walk 20 blocks instead of jumping in a taxi (and give yourself the time to do so). Pack lighter for a week-long trip so as to avoid having to check a bag, or just fly Southwest. Buy a Brita and a durable water bottle (you’re going green and saving at the same time). These are just some simple quick-fix solutions to give individuals a little more breathing room when it comes to their daily budget.

When discussing quick-fix solutions within your company rather than your personal life, it is more difficult to legitimize them. There is one shortcut, however, that is bound to deliver significant results. MasterNegotiator.com is a self-service strategic sourcing site that offers companies free access to preferred pricing for commonly purchased items and services. The pre-negotiated contracts available are normally offered exclusively to high volume customers. The site provides a free, quick, and easy way for businesses to save. Categories range from office supplies to pest control services. MasterNegotiator.com is not a makeshift remedy that has high risk side effects but is rather a tested vaccine ensured to strengthen your company’s immune system. The site is designed to meet the needs of companies of all sizes.

Some spend categories require a more customized sourcing strategy. In order to position your company for growth as the economy recovers, be sure to utilize multiple sourcing strategies rather than a single solution across all areas of your budget. MasterNegotiator may be the best fit for your office supplies spend, but your telecommunications needs may call for a more tailored solution. Therefore, the quick-fix should not be nixed, but rather used in combination with other sourcing strategies.

Many individuals are short on resources under the current economic conditions. There are solutions in which additional resources are available to help you produce cost savings results without adding to your company’s cost structure. With some solution providers, there is no need to be concerned with whether or not the soft costs associated with a sourcing process will pay off in the hard costs savings. The extra human capital available with solution providers will perform research on current market trends, analyze your incumbent supplier’s competitors, implement best practice processes and engage alternative suppliers to begin building potential relationships.

With assistance from solution providers, you can establish more efficient procurement processes that deliver savings. However, if a contract is implemented with a new supplier or better pricing is received from an incumbent, the process is not yet complete. Reporting issues may arise, compliance issues will always exist, and there may be some instances where the contract pricing agreed upon is not in place, requiring a monthly audit before credit requests are no longer needed. It can be time-consuming and sometimes frustrating, and attention to detail is required; but it is always important to realize that these tasks serve a purpose and that in the long-run, all you’ll need is a first-aid kit.
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Waiting to exhale?

on Friday, September 4, 2009

2009 will be remembered as one of the most tumultuous years in American business. The American Auto industry finally collapsed upon itself. The American finance and insurance sector crumbled under the weight of its own rampant speculation. All this, while the American people shouldered the burden of years and years of business built on ego, greed and business decisions that had little to do with business.

When you consider the math of the Auto industry alone, the facts are staggering. The world has about 800 million cars and light trucks in service, of those over 250 million or 31% have American owners. That’s right, America not only makes the most cars and trucks, we own the most cars and trucks. While the tide is turning, Europe and Asia surpassed the US in new car/truck purchases in 2007, the US still places third on the list of new car buying regions. So imagine the brute force economics of owning, maintaining, repairing and replacing that fleet of 250 million units. Let’s say the average cost is $1,000 annually, per unit (probably a very safe estimate). That’s $250 BILLION of economy churning every year. Now let’s constrict that market by 10%. That’s a $25 billion delta. In human terms, $25 billion of lost sales, lost jobs, unpaid bills, etc.

And if we calculate the societal effects of the constriction of the banking and finance industries, the math is even more frightening. So let’s save that for an even brighter day.

Because the panic has passed; the news that the worst is over has already allowed many institutions to lurch back into business as usual. Those “urgent” cost savings measures that were years too late; they’ve already been back-burnered or shelved altogether in favor of key operational initiatives, such as installing new time clocks, or software upgrades. Pardon my sarcasm.

Here’s why. People do what matters to them. The companies that suddenly decided cost savings were an issue because of financial panic immediately abandoned that cause as soon as their line of credit re-opened. The companies for who cost savings, control and containment were long an issue, still look hard at costs. Emergencies don’t change us, they just change our behavior (temporarily).

So consultant beware, the client that suddenly woke up and decided that cost savings were a priority is not your true customer. They were all hot and bothered in Q1 and Q2, and now they’re not returning your calls. Probably because they were just waiting to exhale.
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Show Me The Value!

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In the sourcing world, people throw the word “value” around a lot. Everyone wants to see the value. “Show me the value, Jerry!” Mediocre sourcing professionals are content once they can see the value. That is, once they have a report that defines the value in “black and white” so they can cover their rears if something goes wrong. Great sourcing professionals don’t just want to see the potential value; they want to know how that value will be delivered. In the first chapter of their book IT Strategy in Action authors James McKeen and Heather Smith go into detail about the concept of IT value and how to secure its realization. I’d like to share their “Five Principles for Delivering Value.”

1. “Have a Clearly Defined Portfolio Value Management Process”

The Portfolio Value Management Process is a system of measures that will help to judge the value of a project relative to other projects or potential projects. It’s also a type of diagnostic that can be used to determine the feasibility of realizing proposed value. This process will help to view the way the potential value of a project may change as budgets are spent and timelines are either met or extended. The Value Management Process also acts as a tool for managers to use to gauge their faith in the project and to protect an investment that may have originally been undertaken without perfect or ideal information.

2. “Aim for Chunks of Value”

The basic premise of this principal is “Go big or go home.” McKeen and Smith argue that companies should focus on a few key areas and design complimentary sets of projects. Managers should focus on the biggest, juiciest, lowest hanging pieces of fruit first, and put most minor initiatives on the back burner.

3. “Adopt a Holistic Orientation to Technology Value”

In this section the authors speak specifically to IT, but the lesson can be applied to any potential value-generating function of a business. Whether it’s IT, or Invoicing, or Quote Requisition, or any other facet of any business, this lesson will almost always hold true. Never view the project at hand as if it is in a vacuum. Every project is related to any number of other projects along the course of a given process. Taking this holistic approach up front will save a lot of headaches when it comes time for the actual implementation.

4. “Aim for Joint Ownership of technology Initiatives”

Again, this section speaks directly to IT but can be applied to any project with an implementation phase. Managers need to get stakeholder and executive buy-in before beginning any sort of project that may require change. The more members of an organization that take ownership of a project, the higher the chances that project will be successfully implemented.

5. “Experiment More Often”

While I whole-heartedly agree with the first four principles, I have a little trouble digesting this last one. The authors argue that, particularly in IT, executives need to be more explorative and open to investing heavily. To their credit, Mckeen and Smith do mention pilot programs as a way to “experiment” without being exposed to a substantial amount of risk. Many of our clients also find that pilot programs (for our services and suggested suppliers) are a great way to see what real value can be delivered.

In the end, the only value that will ever be realized is value that can be delivered. Don’t just look for potential value. Ask the question, “How is it going to be delivered?” While a project is being implemented, ask yourself “Does it seem like I’m going to get the same value I was promised?” Get everyone on board, aim for the low hanging fruit, and always view the project at hand as a part of a bigger process. It may seem like common sense, but I felt that it was worth sharing the read.
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What's Not to Like About Bing?

on Wednesday, September 2, 2009

I have been using Microsoft's new search engine Bing for one month and I like it better than Google.

Search results are clean and easy to read. On the right side of the page you can see related search terms, categories and a history of your recent searches. If you highlight a search result, you get a summary of the related web page without clicking. This saves a lot of time. Video clips can be played by highlighting. No need to click and leave the search results page if you don't want to.

The home page features new photographs daily. The photos are often interesting and scrolling over the photos reveals fun facts about the photo. Another enjoyable feature.

Microsoft has produced a best in class application with Bing. Try it, you might like it.
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