April 2009
According to the latest edition of Lubes ‘N’ Greases magazine’s “Base Oil Report” (Page 52), base oil markets seem to be showing signs of life. The article starts off by citing the week-over-week increases in demand during the month of February, and then goes on to discuss some possible pitfalls that could sabotage the historically demand-generating effects of the auto industry and summer driving. I found this article particularly interesting because of the ramifications the information it presents could have when dealing with lubricant suppliers.

As I stated about a month ago in a posting titled “The Lubricant Roller Coaster: Are You Strapped In?”, negotiating transparent and traceable price-adjusting mechanisms is just as important as negotiating the pricing itself. If at all possible, it is imperative to outline clear price adjustment methods during the contract development process. So what if you’re already stuck in a lubricant contract that doesn’t? What do you do if you feel that being in the dark leaves you with no option but to accept your suppliers’ price increases? You get smart and become a pain in their ass. When pushing back against supplier increases, knowledge is power.

Okay, so you don’t have access to whatever convoluted, asinine index your supplier is using to justify an increase. And you probably don’t have time to track all the indexes and economic factors that you would need to formulate a solid argument. What you do have is access to the wealth of summary industry information that’s available online and from independent trade publications like Lubes ‘N’ Greases. Without a leg to stand on or compelling information, a price increase conversation could easily go like this:

Supplier: “Our costs are going to go up, so we need to increase your price by 10%”
Purchaser: “But haven’t crude prices been decreasing or staying flat?”
Supplier: “Well yes, but the base oil markets are all about demand and capacity. It’s not that simple. Week-over-week increases in demand for base oil stocks have caused our market demand forecasts to rise significantly. This, in turn will cause our costs to rise and…blah…blah….blah…we’re going to need to pass some of this increase along.”
Purchaser: “Well then, I guess that makes sense.”

After all, for many sourcing professionals, lubricants are an indirect spend category they may not be able to spend time tracking. Now let’s say you are strapped for time, but have managed to squeeze a few minutes in to read an article like this month’s base oil report. After his reasoning you would be able to respond:

Purchaser: “How can you possibly justify this increase? During the first six months of 2009, automotive production-a key indicator of an active base oil market-has fallen by 41 percent! February US auto sales fell to their lowest annualized rate in 27 years! Plus, you and I both know that the forecasts for summer traveling aren’t looking too bright. I don’t know what index you’re tracking, but these signals certainly seem to suggest weak demand for base oil.”

Now this probably won’t cause the supplier to wave a white flag and back down, but they’ll at least have to ditch their usual glib “reasoning” and actually talk about the specifics of their pricing with you. This will open the door for you to make valid, logical arguments that, with a little pressure, will seriously improve you chances of lessening or altogether avoiding a price increase. The point is that you don’t have to be a subject matter expert to have enough subject matter knowledge. There are a number of resources sourcing execs can take advantage of to supplement their knowledge of indirect categories without spending hours tracking and researching a hundred different markets. If you leverage these resources properly, you’ll be able to efficiently stay on top of enough information to show suppliers in any industry that you know how to play hardball.
At the heart of the news, one story exists. And boy, I wish it was a fictional one. It was reported this morning by msnbc.com and NBC News that a 23-month-old Mexican child is the first swine flu death occurrence in the United States, having died in a Houston hospital (the full story). The child was visiting family members in Texas when he began to develop symptoms. There is said to now be almost 100 cases of the swine flu currently in the United States and that number could increase before you finish reading this blog. Mexico has been hit the hardest by the outbreak, having reported more than 150 deaths and 2,400 illnesses. More cases have appeared in other countries as well and the World Health Organization is considering raising its pandemic alert level to phase 5.

I do not want to repeat what several blogs have already touched upon regarding this outbreak. Supply Chain Matters and Spend Matters are just a few blog sites that have already discussed the impact the swine flu could have on companies’ supply chains. Great emphasis should be placed on assessing the risk this outbreak may have on your company. As global panic escalates, supply chains may weaken.

To try to make light of the situation at hand, I thought I would compare the story of “The Three Little Pigs” to the swine flu outbreak and discuss how the old folktale relates to a company’s supply chain. The main characters of the rapidly changing swine flu story, however, are not protagonists and there is no happy ending in sight. I will assume that you are familiar with the story, but I will provide a quick rundown to refresh your memory. Three little pigs are sent out to live on their own and provide for themselves. Their first instinct is to find materials to build a house. The first pig comes across a man with straw and asks (I like to think the pig negotiated) for some straw to build a house. The second pig does the same but uses sticks and the third pig chooses brick. A wolf on the hunt for some pork comes along and simply huffs and puffs and blows down the straw and stick houses and eats up the two pigs. The wolf then makes his way to the third little pig’s house and attempts to blow the house down but is unsuccessful. After several blown efforts to con the pig out of his house, the wolf decides to enter the house by way of the chimney. The pig realizes the wolf’s plan and sets up a boiling pot of water at the foot of the chimney. The wolf falls into the pot and the pig places a lid on it, and boils the wolf for dinner.

Imagine the three little pigs as being three different companies. And imagine their houses as supply chains and the wolf as the swine flu. Building a strong supply chain is like building a brick home. When you stack brick upon brick it’s similar to having a plan A, B, C, D, etc. for when there are risks to your supply chain. The challenge is trying to identify those risks and developing plans to avoid or lessen them. Sometimes, the only way we are able to fully identify a risk is by facing a supply chain failure. Did your supply chain fail or face a disruption after the SARS outbreak or Hurricane Katrina? If so, did you adjust and plan for possible similar occurrences in the future? The difficulty is you are being asked to expect the unexpected and take into account all possible risks that could impact your supply chain.

At a time like this, you need to ask yourself, what would happen if my main supplier went bankrupt? Have I provided myself a cushion to withstand a supply disruption without serious repercussions? Am I able to allocate ample resources to create a risk mitigation strategy?

Take a look at the following series posted this past summer regarding risk management and all the factors that go into having a strong supply chain:

Are You A Gambler?
How Much Are You Betting and What are the Chances of Losing?
Gamblers Anonymous

This series discusses what your company should focus on when it experiences a major supply chain failure. It also directs you on how to begin to identify risks in your supply chain. The benefits that come with a risk mitigation strategy are also touched upon. These discussions dive deeper into what your company may be facing as the swine flu poses a severe threat. Hopefully, these posts will help you be prepared for the unexpected, even for when a wolf attempts to blow your house down.
I have the opportunity to review contract terms and conditions for many of our customers, across all types of industries, goods, and services. Some of these are for existing agreements, and some are new contracts/supplier partnerships. Once in awhile I will come across a clause that really makes me cringe. Over the next few weeks I will review some of the worst clauses I see that show up in contracts over and over again.

One of the worst is the Most Favored Nations Clause. David Bush provides a good definition of this clause on the EC Sourcing Wiki. To quote David - "In the event of a price decline, or should you at any time, during the life of this agreement, sell the same materials or service, under similar quantity and delivery conditions, to ________, at prices below those stated herein, the agreement vendor will immediately extend such lower prices to ________."

David notes several problems with this clause in the wiki, including how do you effectively negotiate it, how do you enforce it, and what are you trying to accomplish when adding this language to a contract?

Most of the time I see this language in government contracts or contracts for extremely large companies/volumes, and all of the time the clause is added by the customer (not the supplier). Typically, the purchasing staff (or legal, or finance) has added this clause to make it appear they negotiated the absolute best rates in the market, and to ensure they never have to look at or think about the agreement again. “I sourced it, this supplier provided the best price, and he is guaranteeing I will always have the best price. I’m done!”

The first problem with this clause is that the language actually gives the supplier leverage not to lower margins with any customers, regardless of volumes or market conditions. A few weeks ago, I had a call with an MRO supplier that was quoting a 10% discount off of list pricing on an electrical bid (I won’t mention any names, but I am sure you can figure out who it was). I explained that most of our purchases weren’t repetitive, but that we can standardize on certain manufacturers that are willing to provide special pricing to the distributor based on our volumes. We asked the distributor to pass along some of that price relief to us. The supplier stated that because they have Most Favored Nations Clauses in other contracts, and those contracts provide for a 10% discount, he can’t exceed the discount for us, even on items where he is getting a much better price. I won’t go into details as to how this argument is invalidated based on the net pricing the supplier provided, but the supplier openly admitted they can’t be competitive due to contracts with other customers. So I get the same 10% for my $500K in spend with Cooper Bussman that company B might receive with $10K in spend.

Under a similar scenario, I envision a buyer going back to the supplier for price relief due to a declining market. I can already here the response, “Well, under the terms of our agreement, you are already getting our best price. We can’t go any lower than that!”

The second major flaw in this clause is that it does not necessarily prohibit a supplier providing a lower price to other buyers. I have a colleague that used to be in the software business. His company was awarded a large government contract where the bid was actually higher than their list price (as opposed to a discount off of list). The government purchaser required Most Favored Nations language in the final agreement, which would not have been possible given that they were charging over 100% more than they would for a typical customer. To get around this, the supplier created a new company that’s sole purpose was to be the executing party on this specific contract. The government contract would be signed under Company B, all other agreements would be signed under Company A. The customer gets the best pricing provided by Company B, but Company B also has no other customers. Say want you want about the ethics of the situation, suppliers will protect their margins. In this case, the supplier found a loophole and took advantage of it. If the buyer did some research, they would have realized pretty quickly how out of the ballpark the pricing was, but they chose to take the easy way out, and they paid for it. At least they slept easy at night.

As David notes in the Wiki, there are times when a Most Favored Nations Clause makes sense, but even when it is added, it is not an excuse to skip your homework. Always consider the market and the purpose before spending time negotiating this clause into an agreement.

In the first example, the supplier provided a broad range of general MRO items. Does the Most Favored Nations clause mean you are getting a better deal, or are you getting the same generic discount that everyone else gets? Does this clause give you a competitive advantage, or does it simply ensure that smaller customers will now get the same discounts that you receive?

In the second example, consider what the clause actually says. Are there loopholes? What pricing does this apply to – is it all products/services provided by the supplier, or just certain net prices and/or discounts provided in the addendums?

Lastly, if you are a very large customer or getting a custom deal you should ask yourself – why am I adding this clause? Markets are constantly changing - new suppliers are adding capacity/distribution/etc, raw material demands fluctuate, and industries are consolidating or breaking up. Markets should continuously be tested. Make sure when you add this clause that you are doing it for the right reasons, and not just to demonstrate what a great negotiator you are. If you don’t, you may end up eating your own clause.
no image
I often drive up the Pennsylvania Turnpike-Northeast Extension (I-476) and North on I-81 at Clarks Summit when traveling to Oneonta, New York (central NYS or “upstate” to those that live anywhere South of Poughkeepsie!). It is very common to see numerous tractor trailer trucks and flat beds pass you by with the “wide load” safety cars or trucks alongside on this route. On one of my travels a flatbed truck passed me, nothing usual I thought to myself, until I looked over again and the truck was STILL passing me. That was the longest truck I had ever seen transporting something on the road! I thought maybe it was an airplane wing being so long and light gray metallic but the shape was not truly that of an airplane. One end was round and then it smoothed and flattened out into an airplane wing shape. What could it possibly have been?

While I kept both hands on the wheel and eyes on the road (who knew what wind force a truck that size might have created on the winding hills of Northern PA) I glanced out the windshield as it continued to pass me. I racked my brain on what else it could possibly be. About five minutes later an identical truck passed by with the same exact cargo and a third truck shortly after. The fourth flatbed that passed me in this sequence looked like what could have been a space ship! I would describe it as large silvery dome like the nose of an airplane with Medusa-hair looking flexible conduits.

Have you guessed what it was yet? They were all parts of a wind turbine! I realized this after seeing pictures and reading a few articles about wind energy and wind farms in Electrical Wholesaling. The American Recovery and Reinvestment Act of 2009 that President Barack Obama granted (aka the stimulus package) provides a number of incentives for investing in alternative energy including tax credits for wind energy production and for the manufacturers.

One of the articles wrote about the rise in demand for specifically skilled workers. Ages from high school graduates on up are studying to be a wind turbine technician. Electricians are getting on the job training and attending vendor workshops and safety lessons to get up to speed on being wind electricians. The environment and work schedules are different than usual for electricians such as temperature, height and wind (obviously) as well as working with hydraulics, lubrication and mechanical equipment. I found these articles interesting to read and to learn about wind turbine technicians and electricians, especially after seeing parts of one up close on the road!

Promoting energy efficiency and creating exciting job opportunities gives a great sense of accomplishment and support during the current economic condition. You may just want to research if your land qualifies for a wind turbine and what’s involved to do so. Or explore the training and schooling options to be part of wind farm building projects! To increase efficiency and see what different types of savings in your company are possible contact us and see what we can do for you!
no image
I’ve been reading a few articles in Business Week and Electrical Wholesaling recently. President Barack Obama granted a $787 billion stimulus package to subsidize the purchase of new technologies by utilities throughout the country with the idea to “make our energy bills lower, make outages less likely, and make it easier to use clean energy.”

There are a few concerns that come to mind in no particular order. First being potential of handing over much more control to the utilities to change electricity prices at will. For example, on a hot summer day when most people will crank up their air conditioning the utility uses its flexibility to increase the rates for whatever community with rising demand. This is purely a speculation that the utility may adjust rates as such to make addition money off consumers.

A second debatable concern is the smart meter. The new smart meter would be installed on customer’s homes to replace the old models which relay electricity use and price information to consumers. This doesn’t sound too bad, right? The meter can also gather usage wirelessly without trucks or meter readers. No person trampling your roses to get a meter reading sounds like a positive but it could also lead to more layoffs for many. A possible positive of the smart meter may be that in time we will learn to use our energy more efficiently if the utility increases their rates during high demand times due to the real time reporting.

Thirdly, there is always apprehension when it comes to spending more money, especially now during a recession. According to one of the
Business Week articles I read, states will have three options for introducing flexible pricing to customers. It can be mandatory, it can be the default with an opt-out or it can be a voluntary opt-in program. We’ll just have to wait and see how this truly affects consumer’s wallets. Just be prepared that you might have to shell out the initial cash to purchase the smart meter too! You never know!

On the flipside to all of these concerns, upgrading our country’s network of transmission-line technology is sorely needed. As with many other infrastructure components (like bridges), we are outgrowing and running existing structures into the ground faster than we can, or will, repair them. Upgrading this system will certainly help power the future in much more efficient ways, and present more green opportunities for energy and sustainability.

In honor of Earth Day, if you live in a test community that is, or will be, part of the pilot, give it a chance! Turn off your electronics, save some energy, plant a tree, clean up debris along side of the road or turn in your recyclables to help out Mother Earth!
The Obama Administration is leaning towards Cap-and-Trade in an effort to reduce carbon emissions. A cap and trade program allows companies with low emissions to sell their unused carbon footprint to companies that are over their pre-established carbon limit. Essentially, it incentivizes companies with low emissions, and requires companies with higher emissions to pay for the right to pollute. While the details on how a program would actually work remain sketchy, the fact is that at some point over the next four years, companies will likely need to start tracking their carbon footprint.

The first question every supply manager will ask is “How the heck to I do that?” Well, there are tools and resources available to make calculating some aspects of a carbon footprint easy, but others remain more difficult.

Most companies can attribute the largest part of their carbon footprint to energy consumption. The DOE can provide you with rule of thumb estimates on how much carbon is generated in the production of electricity, by state. Of course, different forms of energy release different types of carbon, so the first thing a “carbon manager” must do is determine what type of plant (electric, nuclear, coal, etc) is providing the electricity to their facility.

The carbon produced during the transportation of goods can be calculated as well, and it is relatively easy to do so when dealing with full truckload shipments. The Federal Government provides estimated MPG standard on every type of truck on the road. With that info in hand and an estimate of the miles covered, the website http://www.carboncube.net/ can give you an assessment of how much carbon those shipments produced.

But what about LTL or small parcel shipments? These shipments typically use hub and spoke routing procedures, which means the shipment does not take a direct route to its final destination. Would these types of shipments even be included in a carbon analysis for cap and trade programs? Most manufacturers and distributors ship as much or more via LTL and small package as they do Truckload, and the likelihood is these types of shipments would be used when calculating a carbon footprint. Right now calculating the carbon footprint of the carrier is possible, but accurately tying it back to an individual pallet of widgets is where things become tricky. According to the April edition of Logistics Management magazine, the Carbon Disclosure Project http://www.cdproject.net/ – “a collaboration of institutional investors and corporate giants” – is meeting this month to develop a framework for tracking and reporting carbon emissions of LTL and parcel shipments back to the individual shipper.

What is the impact to supply chain managers? In the past, the fact that a shipment from your warehouse in Philadelphia got to its final destination in Tampa by way of Memphis, Louisville, and/or Indianapolis didn’t matter, as long as it got there in three days. Now, with the carbon cost of that shipment being tracked and accounted for by your company, you will need to pay attention. Not only will it require the Supply Chain/Logistics manager to take a second look at their routing guides, it will force the LTL and Small Package giants to rethink their hub and spoke routing methodology or invest in greener/more efficient transportation methods to drill down on the “carbon cost” concerns of their customers.

The freight industry as a whole hurting right now, and rumors are flying about who might fail. Needless to say, some carriers may find the additional stress put on them by customers restructuring their supply chain to account for carbon costs may be too much to bear. As cap and trade turns from talk to action, chance are some of these carriers may close up shop or break back up into regional carriers.
The Blogsphere has provided some recent entertainment and a little excitement with a rant from Jason Busch of Spend Matters and a response from David Clevenger of Corporate United. It’s often fun to sit on the sidelines and watch two intelligent and clever pundits match wits and battle it out.

Jason and David are both right. They fall short in that they do not get to the crux of the issues inherent in sourcing organizations. The problem is that many sourcing organizations (I use the term lightly) are not doing anything that is strategic in nature or part of any overall corporate strategy. Most of the supposed strategic sourcing groups (even in Fortune 100 companies) are not operating as a strategic component of a grand plan nor are they executing a well thought out and cohesive strategy that is an integral part of an overall corporate strategic plan. Do some companies get it right? Of course, but those are the exception, not the rule.

As with most trends, companies jump on the band wagon with little thought or planning. “If strategic sourcing is hot then we have to have it or at least say we do it”. In most organizations, strategic sourcing groups are reconstituted purchasing groups with new strategic sourcing titles. Sourcing managers are still battling the functional domains of Engineering, Information Technology, Human Resources, Administration, Supply, Legal etc. Functional heads do not want to give up the authority and power that comes with a large budget to spend. No one wants sourcing looking over their shoulder or slowing down the buying process with “strategy”.

Strategic sourcing is a process by which the skills of the supply industry are harnessed to optimize sustainable competitive advantage for the business and its customers. The objective is to develop a secure and responsive supply base capable of meeting current and future business needs in terms of quality, flexibility, delivery, cost, technology, service and quantity. Accomplishing this objective, requires being informed of future plans and then deploying a myriad of tools and strategies in concert to address dynamic markets. Strategic Category Management and Strategic Sourcing are not interchangeable or replacements for each other. They are just two possible alternatives that can be utilized to address a specific business need at a specific time.

How many companies look at their sourcing group as giving them a “sustainable competitive advantage”? How many companies have a Chief Procurement Officer that sits on the corporate executive committee, reports directly to the CEO and is involved in all strategic planning including new product development and acquisitions? Show me a company where the sourcing organization has control over 100% of spend and is integrated into all buying decisions for all functional departments.

Quite often, sourcing is an afterthought. Engineering designs and develops a product with little to no involvement from the sourcing organization. Sometimes the new product uses components that are sole sourced or from suppliers that are not financially secure. Sourcing then has to clean up the mess. Other functional departments sign contracts with multiple suppliers that contain contingent liabilities. When the sourcing organization tries to consolidate the volume with one or two suppliers, they find out that significant penalties must be paid to exit the incumbent agreements. Acquisitions are announced and then purchasing tries to figure out how to integrate, consolidate and leverage the supply chain and spend of the acquired company.

Is there anything wrong with operating in this fashion? No, as long as a competitor that “gets it right” does not come along. Companies go out of business every day.

Who has gotten it right? Boring old Walmart. They strategically integrated low cost provider into every functional area of the company – from IT which measures product turnover and profitability to corporate travel where everyone shares a room (including the CEO) for business travel. Now that they are attempting to move some of their fashion items upscale to compete with Target, sourcing is negotiating slight design changes with suppliers so Walmart stores have unique product to sell. All functional areas at Walmart are a part of a well executed strategic plan – sourcing, supply chain, IT, HR, travel etc. etc. Walmart has put a lot of companies out of business.

How can companies get it right – be it Category Management, Strategic Sourcing or just plain old purchasing? Here are a few thoughts.

Develop Sourcing Leadership – Sourcing organizations need a leadership equivalent to the CFO, CIO that has executive committee representation and reports directly to the CEO.

Integrate Sourcing Strategy to Organization Strategic Plan – Sourcing needs to know the plan before the fact so they can develop strategies which will provide a competitive advantage. It is difficult to plan when you are always reacting and playing catch up. Sometimes process improvements and other changes can yield greater savings than unit cost reduction.

Watch Markets – when markets were volatile this past year and oil was soaring, how many companies had a strategy to respond rather than react? Not many. Strategies have to change as markets change.

Develop A Supply Chain Map – see How Much are You Betting and What are the Chances of Losing.

Increase the Education of Sourcing Professionals – The same strategy can not be deployed for the same category over and over again. Markets are dynamic and the strategy needs to change as markets evolve. Sometimes you are managing the category, other times you are sourcing and sometimes you are putting out fires. When you are sourcing, there are many strategies in addition to having 3 or more suppliers answer an RFP.

Provide Spend Analysis and Sourcing Tools – Detailed visibility into spend and specifications are critical to results. How can you effectively source when you don’t know what you are buying? Many organizations are still in the infancy stages when it comes to tools – Spend Analysis, E-procurement, Contract Management etc.

Last but not least, sourcing is an applied science. Don’t rely on process or tools too much. They exist to provide structure and efficiency. The results are achieved by skilled professionals. Two people with the same process and tools will not get the same result. Be aware of the tools and strategies available and develop your skills at using the right ones at the right time. Just as an e-tool does not take the place of a dialogue with a supplier, Strategic Category Management does not take the place of Strategic Sourcing.

I only scratch the surface here. Books can and have been written on this subject. Hopefully the Busch rant and Clevenger response have initiated a dialogue that will be good for all sourcing professionals whether they are consultants, technology providers or employees. What thoughts do you have on the subject? How do we raise awareness and move the profession to the next level?

For those that have given up - try MasterNegotiator.com.

As long ago as 2002, the BBC news declared that internet browsing has reduced our attention span to approximately nine seconds, which in the animal kingdom is tantamount to that of a goldfish.

After thinking about that for a second or two (pun intended); I envisioned how long a goldfish swims before changing direction. It makes sense. They have an attention cycle, they swim a path and then they shift direction. Probably about 9 seconds on the average.

Have I lost you? Or are you still interested?

One fact is simple; internet access has expanded the number of choices for information exponentially. It stands to reason that with more choices the reader is likely to feel freer or even under more pressure to review more information in order to “educate” themselves about a given topic.

Are you still with me?

Ted Selker an MIT expert on online reader behavior (yes, THE MIT) stated that the way we do things affects our attention span. Thus, it’s reasonable to conclude that the light speed access to a seemingly unlimited supply of choices with a limited amount of time in which to review those choices means less time spent reviewing each choice.

Don’t click that link . . . .

Studies show that even the most engaging websites keep the reader’s attention for approximately 60 seconds. Those sites are considered “sticky”. They’re “sticky” because they keep the reader from moving on to your competitor’s site; which is just a click away.

So there’s the challenge at hand; becoming and staying “sticky”. It means delivering compelling content, from the dazzling, glamorous world of procurement in a pure and concise fashion, that will keep the reader’s attention for as long as an entire minute.

That being said, you’re thinking about the next site you’ll be visiting, now.

Hold on a second . . .

If you’re still reading this, and odds are you aren’t. There’s more to come in our next post.

Source One Management Services, LLC will be attending the ISM Conference again this year. We will be in Charlotte, NC this May 3rd-5th, 2009.

Feel free to stop by to discuss:

Stop by and see us in booth #200, or if you would like to schedule a discussion outside of standard exhibit hall hours, call 215-902-0200 (extension 1).

We hope to see you there!
Credit/Market Trends
Interestingly enough, although Jet fuel prices have plummeted from $4.30/gal last year to around $1.40/gal, Airlines have been hesitant to hedge, due in part to the notion that prices may drop further or that they’re still absorbing the beating of bad hedges. At least that’s the opinion that analyst Jesup & Lamont offered.

Could it be that Airlines, like all other businesses, are simply unable to hedge on get while the getting’s good jet fuel prices? True, Airlines didn’t invent borrowing to hedge, but it’s safe to assume they’re having trouble freeing up cash too.

There may be good news on the horizon, though. The NACM (Nat’l Association of Credit Managers) reported a second month of improvement in the Credit Managers index. While March’s increase was only half on one percent, it followed a 2.5% increase in February. Not exactly a quantum leap for credit, but certainly a positive sign.
Petro Chemicals/Market Trends

Barclay’s Capital reports that the dip in chemical manufacturer profits is likely to last into 2011. The recession and credit crisis has pinched consumption to below (already low) expected levels. Even that projection relies on economic recovery in 2010. Capacity shutdowns and delay of new project openings will also slim supplies (ICIS.com).

Will the effects of abundant, lower priced commodity chemicals reach the end user? Well, the consumer has seen the benefits at the gas pump; where prices are 40-50% lower than this time last year. The degree to how much procurement will be able to capture the downstream benefits of the soft market will have much to do with the price programs and sourcing strategies they employ. Needless to say, the manufacturers will hold the line for as long as they can, unchecked.
Steel/Market Trends

Analysts at MS (Morgan Stanley) predict a steep (41%) decline steel prices from last year’s average $854 m/ton to an average $502 m/ton in 2009. Additionally, MS projects an 11% cut in global demand, leaving steel markets oversupplied. Most notably, inventories in China have reached historic highs. All this in the face of a 24% cut in global production (purchasing.com).

Does this trend spell relief for two ailing American institutions, auto and home builders? It’s too soon to tell. Manufacturers could, under heavy price pressure, simply pass along the savings to the customer. Home sales have slipped drastically, but would incrementally lower prices make any difference in a credit tight market? Likely not. And how can profit starved GM and Chrysler afford to pass along any cost savings without further eroding an already weak price structure? That’s a tough call. Further discounts on what many are already considering distressed merchandise, could lead to further eroded consumer confidence. No matter how we look at it, lower steel prices will not equivocate to a fire sale on American homes and autos. We’ve seen these trends before, with little if any effect on these two manufacturer’s price points.
Recently I have been involved in electricity and natural gas utility sourcing for one of our clients involving multiple states. One of the first tasks was to identify which U.S. states were regulated or deregulated for electricity and natural gas. Moving forward with another one of our clients I discovered while Pennsylvania is technically deregulated for electricity there is no market for competition (FYI - natural gas is currently deregulated as well but this blog focuses on electricity regulation).

Upon further research I found a great ‘webinar’ presentation from third party supplier Constellation Energy. I had missed the actual presentation date by a month or so but fortunately it was recorded and posted on their website (Go to Archive of Webinars at the bottom of this linked page to playback). I’d like to share some of the information from this presentation specifically regarding the deregulation of Pennsylvania Power and Light (PPL) utility customers. Note that quoted items are taken from Constellation’s webinar presentation mentioned above.

“In 1996, Pennsylvania enacted the "Electricity Generation Customer Choice and Competition Act." The Act provided customers with the opportunity to buy their electricity requirements from a competitive supplier rather than from the local utility. The Act also froze PPL customers' electric rates at 1997 levels through the end of 2009. Now, PPL will transition its rates to market levels starting in 2010.” That’s right, you heard it! This Act started the move to market based rates. Rate caps are coming off in a very different environment then when they were set in 1997. Where were you 12 years ago?

To add to the confusion, PPL rate caps are set to expire at the end of 2009 but the other PA utilities are set for the end of 2010. In response, PPL has created a “bridge plan” to help bring themselves into line with other utilities. Procurements of default service power supply have already begun for 2010. Although the final rate will not be known until all procurements are complete, current results imply there will be an approximate 35% increase in rates depending on your rate class (i.e. residential, small business, commercial and industrial). “PPL also has a 2011-2014 default service procurement plan being considered by the commission currently which is similar to the Bridge Plan.”

PPL’s Proposed Rate Mitigation Plan offers its customers a choice to ease the transition to market based rates. Customers may “opt in” to deferral of the post 1/1/10 rate increase which entails a deferral with 6% interest being repaid by the end of 2012. Participating customers would receive a bill credit intended to limit the rate increase to 25% for 2010 and an additional 25% for 2011.

With all this talk about rates increasing you might wonder if there are any benefits of competition. The webinar presented the following information.

“Competitive markets benefit customers by:
~ Efficiently matching supply and demand
~ Providing mechanisms to manage supply and price risk and volatility
~ Allowing suppliers to compete stimulating innovation of products and services
~ Optimizing generation fuel mix and operational efficiency
~ Generating price signals to incentivize new generations development where and when needed
~ Providing mechanisms for the development of green products (renewables, demand response, energy efficiency)”

If you aren’t already familiar with the inner-workings of how electricity is brought to you, this webinar also provides an easy to read chart. Essentially broken out into three portions as I’ve shown below.

With competitive supply (generation) options customers have the right to choose a competitive supplier for their electricity needs. The utility (PPL) still provides distribution service and there is no impact on reliability. So if you are currently with PPL, make a mental note to start shopping around later in the year and you just might save some green! If you are not located in PA I would suggest you look into your current supply rates and don’t hesitate to start shopping around for a better rate if your state is deregulated. Either way, check out the full webinar to fill in any blanks above and contact us if your business is interested in pursuing utility savings today!
Recently Charles Dominick (Purchasing Certification Blog) conducted a sourcing project for office supplies. He is still in the process of writing this multi-part series.

During the sourcing process "We wanted to compare the proposal pricing to what we had gotten through our rigorous sourcing process. We spent dozens of hours on this process, issuing a formal RFP, and doing all the things typically done to maximize competitive pressures", says Dominick on his blog.

The Strategic Sourceror was pleased to find out that the deal on MasterNegotiator.com was selected as the best total value by Charles after his rigorous sourcing process was completed. Charles goes on to conclude "Technically, from a pure cost standpoint, it was not worth the resources we dedicated to sourcing. If we weren’t doing this exercise for blog material, we would have been better off just going with the deal on MasterNegotiator.com and not spending our time sourcing".

MasterNegotiator.com will continue to add additional categories and best in class contracts to the site for purchasing professionals that want a self service model. Many companies do not have the resources to conduct a full blown sourcing process or their spend does not provide them with the leverage to negotiate steep discounts with suppliers. For companies with larger spends, custom sourcing is available through Source One Management Services.

Helpful Links:
no image
So keeping this in mind, what happens in procurement? Much like procurement imitates business, and business imitates life, prepare for more tough transitions. People will still buy cars, but there may not be GM and Chrysler logos on them. Will Toyota, Honda, Nissan, VW etc. swoop in to fill the demand? Absolutely. It’s important, as a good friend used to constantly remind me, to see the universe in balance. Supply and demand may shift, but they never disappear. The folks who used to work for GM and Chrysler will work for whatever emerges from the ashes, or Toyota, Honda etc (as many do already). There remain over 300 million Americans in the US, all of whom consume something at some time. Folks will continue to buy and sell as they always have, there will be no halt to business; only a change in the manner in which we do business. Considering the current economic climate, it’s long overdue.

I’m not sure about the rest of you, but it gives the Sourceror hope.
no image
Little surprises me anymore. But when the president of the United States fires the last chair of the American auto industry, I have to admit, I didn’t see that one coming. If there was any question that President Obama might not follow through on his promise of “change’, he answered with clarity.

Firing Rick Wagoner sent a number of messages. One message was that the good money on bad era is over. It’s been abundantly clear that GM and Chrysler were satisfied to continue an internal bartering process with their bloated infrastructure. Then, when the books didn’t balance, they’d fly in on their private jets and show up on Capitol Hill with fedoras in hand. It’s a process that began in the 1970’s and ensured their demise in the current climate.

A more important message is that business as usual is hereby terminated. The fact is that GM and Chrysler have failed as businesses. On paper, they’re a fire sale waiting for the auctioneer. For some reason though, our history has been one of staving off the inevitable by gouging the taxpayer. Folks hear that GM and Chrysler are begging the government to finance their inefficiency, bloated workforce and lower quality products. But the truth is, they’re asking every American taxpayer to dip into their pocketbooks and pay a premium to keep them swimming in empty real estate, overpaying underperforming laborers and producing cars that hold a fraction of their value compared to the competitors. Ironically enough, they ask for this while “foreign” automakers outperform them on their own turf.

But here’s the most important message. We have a President who will finally hold Lear Jet beggars like Wagoner accountable. Barack Obama has sent the message that we will finally weather the tough transitions necessary to right the ship. That is, if the ship is right-able. Of course Wagoner, and the rest of us never saw it coming. But has there ever been a more symbolic figure of the sleepwalking, “business as usual” condition of American Business?

Now Mr. President, what about Robert Willumstad?
no image
Sometimes, the Sourceror just can’t let go. Last week I chipped into Jason Busch about his blog on Performance pay. There’s one point I missed in the discussion. The bonuses paid to many AIG employees were not performance pay at all. The extra cash was paid out as “retention bonuses”. In theory, these bonuses are awarded not on merit, or performance, but merely to keep employees from jumping ship for greener pastures. Without having access to the full details, and based on the true read of “retention bonus” it would appear that retention bonuses had nothing to do with performance and were in no means tied to company profitability. Now I’m not stumping for the AIG pirates who took huge sums of money while the company teeters on the brink of its failure, but a deal is a deal. So blaming the folks who took the money they were promised is tantamount to blaming anyone else for taking the pay they are promised as part of their working arrangement.

I should have caught this too and mentioned it in my last piece. To put things in perspective, take a look at this AIG Financial Products Employee's Public Resignation Letter.
no image

My older sister is on Spring Break this week and I began reminiscing about my college years. I remember the infamous traveling agencies that would come to campus to sell their Spring Break Packages. All of my friends couldn’t resist opening the credit card account to purchase the package and fly high to their destination. But I was always the cautious one (they like to say that I’m just cheap). I would create my own package. I would shop on the internet and purchase my flight and hotel accommodations ‘a la carte’. I came across Southwest Airlines one year but they weren’t flying to my destination but I ‘bookmarked’ them because I was very impressed with their low prices….

A few weeks after my Southwest discovery I was assigned a business case about Southwest for one of my finance courses. My Finance professor told me in April of 2005 that if I invested in LUV (Southwest’s stock) for one year that I would see a return of at least 11%. And guess what? He was right! On March 22, 2005 LUV closed at $14.05 and on March 22, 2006 LUV closed at $17.70 (that’s a 26% return). I am risk-adverse so of course I didn’t believe my professor or his teachings of the famous CAPM equation that magically calculates the expected return on a stock when given the expected risk.

[I missed out on that investment opportunity, but I wonder what my professor is telling his students to invest in this year (Considering the current financial crisis). Do you think I would take his advice now? Probably not!! I’m still trying to figure out how my “low-risk” mutual fund fell 36% in October 2008. No more investments for me!]

Now back to Southwest. What an amazing strategy they HAD! Let’s go over how they managed to be one of the few profitable airlines in the world.

Fuel hedging. Whoever managed their financial derivatives did a superb job. Southwest purchased swaps and call options to secure fuel price in future years.
Human Capital.
One aircraft Model.
No Hub site.
Can only buy tickets from Southwest. Not on Expedia or third party sites.
Customer Service. There are no assigned seats, the flight attendants sing songs, and no hidden fees (literally).

Southwest managed to fly high above their competitors and achieve a profit for the 35th consecutive year in January 2008.

Unfortunately, Southwest was not able to exclude themselves from the financial disaster during October of 2008 and took a loss. But, let’s give credit where credit is due. All Aboard!!

So I conclude with this…. The fabulous financial equations that I spent 2 years learning could not have calculated the tragic financial events that happened in October 2008. Almost everybody has been affected by this. So we all need rethink about how we consume. Most of what people buy, they do not need. Let’s spend a little more time shopping around for lower prices. Be proud when your friends call you cheap! You’ll be better prepared to handle the economic conditions we’re currently in. And let’s not forget to read the small print of those credit card offers, vacations packages, and loyalty programs.