The toughening economic climate – A ‘call-to-arms’ for the procurement function

At present there seems to be two schools of thought regarding the impact that the global economic recession is having in South Africa. People are either sure it is real and are dramatic in their response, or they are pragmatic in a perception of resilience through non-exposure.

The recession is real. For the average housewife it is not yet critical, although the price of food continues to rise, and so will most other consumable products that she buys. For certain industries, for example automotive manufacture and retail, and mining, there is no doubt that the pressure is on as revenue shrinks or dries up and the price of commodities nosedives on the world market. For many exporters, the market is damp or severely retarded.

The procurement function has the propensity to assist with a response to this climate through the management of risk and the reduction of cost. The questions to be asked are:

* Will procurement be allowed to assist?
* Will procurement assist?
* What will procurement do to assist?

Perhaps this is the opportune time to state the value case and increase the mandate of the Procurement function”, Greg Buckley, an Executive at Volition Consulting Services, told SmartProcurement.

In organisations where the procurement function carries the correct status, this is an exciting time for procurement – a time where procurement can really lead in terms of business and profit sustainability.

So what are the symptoms of the current climate?
Firstly, the sales revenue and bottom-line results of organisations are under pressure. Forecasts and targets are difficult to achieve, and the sums show that the difference between profit, break-even and loss is small. The equation is furthermore temperamental and in need of acute management. One of the first places that executives look to cut cost is in the supply chain, and they are expected to target the purchase prices of direct and indirect materials and services.

Secondly, in many industries the input cost of products has become unpredictable. In most instances, the input cost is increasing and this puts direct pressure on bottom-line results. “Where the volumes ordered have not changed much, this increase does not seem to make sense to those buying, given that basic economics dictates that prices should fall when supply exceeds demand. The favourable oil price, which has dropped dramatically in twelve months, has not had the expected general impact on input costs. Pick ‘n Pay, for example, has expressed its discomfort with rising prices and has called its first tier supply base together to attempt to decipher this phenomenon and to lay the foundation to collaborate and manage the risk. In other instances input costs are decreasing. An example of this is shipping costs where the prices of containers has taken a major dive as harbours worldwide clog up with idle ships. Despite the current anomalies, input costs are expected to reduce in general in the longer term, but it is the shorter term that must first be survived”, Buckley continued.

Thirdly, the actual survival of organisations, and therefore the continuity of supply to their customers, is at risk. International organisations are currently at a greater risk, however, local organisations are not immune. The most obvious casualties are those businesses that have all or most of their eggs in a single industry or client basket, and those that export their products to markets facing recessive conditions.

So we are, as usual, faced with a colourful blend of opportunities and threats. This is perfectly normal. However, in the current climate, it is critical that the threats are managed immediately as complacency could shred short and longer term profit, and threaten an organisation’s competitive position.

But what should procurement do?

Continuity of supply
The first impulse is to attack the price of commodities. In some situations, and for some commodities, that may be sensible right now. However, it is recommended that organisations first focus on their strategic commodities, especially where these represent dependencies for operations and/or commercial transaction. The first goal is thus to ensure the continuity of supply.

It is pointless getting better prices from a supplier who cannot supply any longer or who does not exist. This is a greater immediate risk to organisations than the unpredictability of prices, and thus deserves immediate attention. The following is a list of actions to mitigate this risk:

  1. Profile your commodities to determine which ones are strategic.
  2. Define those commodities which, if not supplied, can stop your operations (or substantially affect the cost of your goods, etc.).
  3. Identify associated supply base/s.
  4. Define a strategy to ensure the continuity of supply.
  5. Implement the above strategy.
  6. Monitor the supply market and adjust the strategy accordingly.

“Often, the strategy for the management of these commodities will involve formal relationships with the organisations that supply them. These relationships are most valuable now. It is important that you know your supplier and his/her business well. It is also pertinent to spend the time understanding the cost of the supply chain and discussing ways in which to manage this cost together, whilst sharing the benefit of reduced risk. Open communication will allow quicker adjustment to unpredicted changes in the market. Similarly, alternative supply can be considered. This can extend beyond the traditional market to non-traditional suppliers that are based elsewhere. This lowers the risk in terms of current supply drying up”, Buckley said.

As an aside to managing the continuity of supply, there might in some cases be an opportunity to consider alternative products and a risk management strategy. Where this is possible, some time can be spent to confirm these alternatives and secure possible supply in the event of either non-availability of current commodities, or price elevation that makes commodities unfeasible.

Cost management
There is no doubt that tougher times will result in downward pressure on the cost of certain commodities, as supply outstrips demand. However, this is not yet proving to be a competent generalisation and thus objectivity and careful selection is necessary. Procurement needs to be on the lookout for these opportunities and take advantage of them, without compromising the health of the supply base. Procurement can play an important role in the profitability of organisations, but it must do so responsibility. Some actions that can be considered are:

  • Define the commodities that are good candidates for cost reduction – typically start with those with lower continuity risk but that have substantial impact on the organisation’s profitability.
  • Define the cost drivers associated with these in detail.
  • Consider the current supply market and the current cost driver dynamics – e.g. the falling fuel price, higher cost of capital, etc.
  • Consider alternative sources of supply.
  • Define an approach to target lower prices.

Implementation in this case will likely be through the Request For Proposal (RFP) process, but may be as simple as approaching the existing supply base for frank discussions leading to negotiations.

A major opportunity may arise from negotiations with international suppliers. As their markets dilute, and with the cost of fu
el remaining below $50 per barrel, these organisations will aggressively seek alternative markets and could thus offer great opportunities for medium to longer-term cost benefit.

“Procurement has the ability to play a leadership role through these interesting economic times. Through the uncomplicated execution of good procurement practices, and with some hard work, the current risks can be managed and opportunities to reach performance targets and to excel can be taken. It is important not only to be focussed on doing what is necessary, but to also consider what will remain when the climate settles. Will the supply market be different? Will organisations be dealing with a number of alternative products? Will the exchange rate have forced a complete change to organisational strategy for certain commodities? Will short term gains, at the expense of suppliers, have created greater risk for strategic commodities? Most of all it is important to be acting now and preparing for change”, Buckley concluded.

Article submitted by Greg Buckley, an Executive at Volition Consulting Services.

Greg Buckley can be contacted at the details below:
Telephone: +27 11 259 4380
Cell: +27 82 450 8567

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