PNPL-Demand Management Prevents Costly Purchasing Mistakes
By: Rob Teplansky, Director, EMSInsight Printed in: EMS Newsletter
Our "Pay Now Pay Later" series of articles has covered a tightly interwoven collection of topics that illustrate how your upfront investment in the right strategies, tools and practices now will yield long term dividends through strong supplier relationships.
- A well managed Spend Analysis program can generate 3% - 8% savings every year. ("Spend Analysis Delivers Bottom Line Value")
- Incorporating key elements into your Strategic Sourcing can significantly improve the outcome of the bid process and success of your supplier relationship. ("Strategic Sourcing: Don't Skip the Essentials")
- The value of a detailed Master Service Agreement early in the sourcing process is incalculable. ("Mastering the Master Service Agreement")
- A good Performance Management Performance typically results in 91.5% improvement in vendor/buyer alignment. ("The RFP is Done, the Work is Not")
- Market Management allows you to deal proactively with situations rather than scrambling after performance has begun to decline. ("Leverage Market Knowledge for Optimum Results").
Demand Management consists of activities designed to monitor and manage business unit demand and internal purchasing processes to ensure that you consistently realize the benefits of your supplier relationships over time. The importance of demand management to the success of supplier relationships can not be overemphasized. Without an up-front investment in demand management (pay now), even stellar supplier performance can be eroded by internal factors that are out of the supplier's control, resulting in higher costs and reduced effectiveness (pay later).
Demand management begins with a thorough understanding of current business unit needs, historical purchasing patterns, and projected demand for the product or service you are sourcing. This research may include a review of purchase orders, product or service specifications, and business plans. Include the supplier in your research. Your supplier may have unique insight into the market for the product or service or its application that may prove valuable to your effort.
If more than one business unit is involved in the supplier relationship, the research becomes more complex and may require additional team members or skill sets to understand why variations in specifications or order timing may be required by different business units. If these differences are not based on need, additional advantages may be found by reducing variation, aggregating volume and leveraging spend.
Armed with a thorough understanding of the needs of your business unit(s), you can create the appropriate processes to streamline purchasing. These processes should incorporate the contract provisions that define your purchasing relationship with your supplier. Important considerations may include:
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'Rogue Spend' Hurts the Bottom Line |
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First, assume that Supplier A provides a discount of 5% on purchases below a volume Y, and 10% on the purchase at or above a volume Y. Further, we'll assume that each of 5 locations purchase the same volume of services. Therefore, at some volume Y, each location purchases 1/5(Y). |
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Assumptions
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Each of 5 client location purchases 1/5 the total volume. |
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The average discount for the company is 10% (5 x .10)/5 = .10 However, if one location accepts an offer from Supplier B, offering a 15% discount, then the picture changes. One location receives a discount of 15%, but the rest of the locations whose aggregate spend is now less than volume Y receive a discount of only 5%. (1 x .15) + (4 x .05)/5 = .07 The average discount for the company is now 7%. On a $10 million purchase, this rogue spend has just cost the company over $300,000! |
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Figure 1 |
- What opportunities exist for volume discounts?
- Does order timing affect price?
- Are the correct suppliers being used?
- Are specific processes specified in the contract?
It also is important to develop the performance measures and key performance indicators you will use to monitor demand and indicate the need for intervention. Educate the staff involved, and clearly communicate your expectations.
The data collected will result in more accurate demand forecasts, which should be integrated into a comprehensive supplier communications program. This information will help suppliers to efficiently manage their resources, resulting in lower costs, which, given a well-designed contract, should also accrue as a benefit to the client.
What are the benefits of demand management?
By investing time and effort to design the right processes at the outset, you will be more likely to:
- Avoid the eroding effects of rogue spend on supplier relationships
- Monitor increases and decreases in the volume of transactions with each supplier
- Track all related costs
- Demonstrate your commitment to the success of the supplier relationship, both internally to your own organization as well as to your supplier
The example in Figure 1, borrowed from the EMSInsight publication, "Developing a Supplier Management Strategy," illustrates the effect of rogue spend on the bottom line.
With the right processes in place, you will be alerted to changes in purchasing patterns that indicate trouble. Referring again to the example in Figure 1, when the rogue location begins to use Supplier B, purchasing volumes under the contract will drop by 20%. Catch this early and you can educate internal staff on the importance of abiding by the approved supplier contract. You can redirect purchasing activity before too much damage has been done to savings objectives and the supplier relationship.
Take this opportunity to understand why the rogue location abandoned the approved supplier. Was it exclusively a pricing issue? Do other problems exist that influenced the decision to switch suppliers? Is this indicative of a greater underlying problem?
Pay now or pay later
A recent survey cited in the EMSInsight publication, "An Examination of Supplier Management Tools and Practices Today and Opportunities for Tomorrow," indicated that demand management represents a significant opportunity for companies. While a full two-thirds of respondents reported that their demand management activities were not meeting their goals, more than half of the respondents had not defined the roles and responsibilities of individuals supporting the activities. Since demand management is a highly structured activity, the results are not surprising. These companies will continue to see disappointing results until they have invested properly in the design and implementation of demand management in their organizations.
A carefully considered and executed demand management program is a powerful tool that will help you achieve the full benefit of your sourcing strategy. An investment in demand management now will enable you to identify and manage, or even prevent, costly purchasing behaviors later.
The series concludes with a look at Demand Management and why the proper internal processes and controls are as important to the success of your supplier relationship as elements that pertain to the supplier's ability to manage anticipated demand.
