Friday, July 25, 2014

Can We Save Good Business from Being Destroyed by Purchasing Departments?

Purchasing Departments are destroying the World of Good Business… And we can Save the Day

Imagine an epic battle. Conjure up a vision of cloven hooved archfiends dashing the lifeblood of our economy. Think about an ever escalating conflict with carnage scattered back to the 1970s. Visualize a place where one side knowingly operating under false assumptions and poorly conceived ideas skews the direction of whole industries.

Am I suffering from a persecution complex? Have I lost my mind? I don’t think so. What’s more I am about to present some scholarly evidence to support my claim.

The claim: Commonly used purchasing practices cause companies to make bad buying decisions.

There are tons of articles pointing to price being about number 5 or 6 on most customer’s list of priorities. Purchasing agents will wave this stuff around like Old Glory, but I have never bought into the story. In spite of all the propaganda to the contrary, experienced salespeople testify; when procurement guys make buying decisions, price is on the top of their list.

I believe there are two interacting issues driving this phenomenon. First, procurement types have a difficult time understanding the value derived from our products, services and solution offerings. Even though many will tout their technical backgrounds or business acumen, very few have the rare combination of technical and financial data to make long term business decisions. Even if they do have a smattering of the background, they often lose touch with the realities of their company’s daily operations. This is more prevalent today because most organizations operate under very lean staffing conditions.

Secondly, purchasing groups are commonly measured on their ability to produce year over year savings. Think about this. A few years ago I spoke to the director of purchasing of a Fortune 1000 sized company. During our conversation, I asked how he measured the performance of his department. His earnest answer shocked me. Recalling the words as closely as possible, he said, “Each team member is measured against their ability to drive costs down by 7% per year.” Since he was buying a complex commodity tied to the price of oil, I asked for elaboration. “Unit price decreases for everything we purchase are the cornerstone of our work,” was the reply. Later on he went on to tell me about how his teams buying decisions often cost money downstream in the production and quality departments. Once again I quote, “…but if the product matches the spec, that’s somebody else’s issue.”

So far my argument has been purely anecdotal and subject to dispute. But let me provide a bit of hard data to convince you the story is correct.

Recently, Design World Magazine ran a piece with data on the use of high efficiency electric motors.  Here are a couple of points to ponder:
• Electric Motors consume over half of the world’s electricity
• Industry uses over 42% of the total electricity
• The purchase price of the average electric motor is 2% of its lifetime cost
• Lifetime electricity usage represents 96% of its lifetime cost
• Repair and maintenance accounts for the other 2%

Research reveals the difference in efficiency between a standard and premium (high efficiency) electric motor ranges from 2-6% depending on horsepower, application and other factors. The typical payback to the user is less than two years. Further, this is not brand new, untested technology. We’re talking about 10 year old stuff. It should be well adapted by now.

As I already alluded, one would imagine the world would be beating a path to the high efficiency motors. This is not the case. Currently high efficiency motors represent only 28% of the motors purchased. My friend Alex Chausovsky, the principle analyst for Motor Driven Systems and Industrial Automation at IHS, says this:

“Individuals making capital expenditure decisions when building new industrial facilities rarely, if ever, consider the long-term costs associated with projects. As a result, these decision makers consistently place initial purchase price concerns ahead of total cost of ownership considerations.”

I have a slight disagreement with Alex; I don’t believe capital expenditures are the only place where decision makers place purchase price ahead of ownership considerations (or plain old business considerations).

When the purchasing person lacks a full understanding of the financial (and/or technical) ramifications of the buy, unit price drives the decision. In most instances, purchasing has their hands on the steering wheel.

Let me go back to the title of this piece: Purchasing Departments are singlehandedly destroying the World of Good Business.
For manufacturing businesses, the difference between the right buying decision and a low price purchase is huge. The right buying decision often carries a higher price tag. But it also has the promise of delivering long-ranging sustainable benefit. Things like fewer defects, higher factory utilization, more products out the door and lower maintenance costs come to mind. And, typically this kind of improvement comes via a cooperative sales effort. This is where knowledge-based distributors come into play.

Here is the rub, knowledge-based distributors sometimes sell the same products as their brown box shipping, order taking counterparts. The lackeys in the purchasing department capitalize on this point. They allow you to invest engineering time, application expertise and troubleshooting efforts early in the life cycle and then “shop” your solution. If they have even an ounce of fairness in their bones (not saying they do…but just in case), they will give you the opportunity to match the price of the supplier without technical expertise. We won’t go into this issue. Instead, we’ll just acknowledge that it happens. And when it happens often enough, most knowledge-based distributors will throttle back on their service levels; damaging the customer’s ability to be successful.

In either case, the purchasing department’s parent organization loses. And that hurts business.

How can we save the day?
Here’s the part about lowly sales guys (Who fight for truth, justice, mom’s apple pie and an incredibly meager commission checks) save the day.

Make it difficult to negotiate price. Purchasing teams learn and practice nickel and dime negotiation tactics. They would have you believe all suppliers are the same. They will refer to your work as “good service” but we know much of it goes well beyond “service” and pushes into
valuable expertise served up on demand. Establish a pricing process which allows you to maximize the gross margin when the customer’s price sensitivity is low. For example, Strategic Pricing Associates (SPA) provides their clients with a pricing cube which considers product type, customer type, size and industry to optimize the gross margin opportunity. And, distributors using SPA report margin improvements in the two point range.

Use a value-metric sales plan. Solving problems is not enough. We need to take the extra step of understanding how our solution impacts the customer. Expand your thinking from “we cut down on maintenance time” to “our solution reduced maintenance costs by $300 per month.” Always tie your actions to the extra dollars produced for the customer.

Report the results of your work as high in the organization as possible. In a world where purchasing departments are judged on their “unit price reduction,” the work you did to help their company make tens of thousands by reducing rejects on the production line means nothing. Sales guys need to establish connections with customer management at the very top. And, don’t confuse the VP of Materials, or whatever the head purchasing guy is using today, as the right spot.

Understand, not all customers are created equally. Some customers can never pay for the expert advice, timely assistance and product expertise you provide via gross margin alone; they’re just not big enough. Others will allow their purchasing department to run amok savaging suppliers for every shiny dime possible. Learn to throttle your free service and think about charging for some of your work. If you have not yet read my book, The Distributor’s Fee-based Services Manifesto invest in a copy. Here’s the link.  

A final word on this saving the day thing…
Saving the day is also about saving yourself. If you happen to be a conscientious hard working distributor sales guy, there will be times where it seems like you’re fighting an uphill battle. Every purchasing pro you chat with will claim to work on a real partnership arrangement. Some may actually walk the walk. If so, great. Just remember, all of the advice is still valid. I implore you… always build a customer reporting structure that gives you an end run around purchasing.

1 comment:

Nicholas Taylor said...

I have to be honest after reading your post, you have got me thinking. I didn't consider a lot of things to be like that until you stated them. You have put a lot of effort into writing this piece and I admire you for it. I am going to take into account your advice because I think it could work for a distributor like me. Thanks!

Nicholas Taylor @ Vancouver Business Brokers