Is Purchasing Stripping Value As It Reduces Costs?
SwitchCrafter makes electronic switches that are installed in the dashboards of large trucks. For years, its biggest customer had been TruckMaster, who bought these vital little parts for $6 apiece. One day, the purchasing powers at TruckMaster decided that perhaps $6 was too much. So the head purchasing guru--let's call him Joe--decided to shop around. He found that CopyCat Corp. sold a switch for $4. So he called up Fred, his loyal SwitchCrafter sales rep, and gave him the "opportunity" to match the price.
Not surprisingly, Fred hesitated. "I'm familiar with CopyCat's switch," he said. "It's a fine part, but the lower price is due to the type of plastic used in the switch. It is not designed to withstand the cold temperatures your trucks operate in, which will lead to a higher failure rate." But Joe dismissed Fred's advice: "That may be, but my job is to reduce the cost of all our parts, and your competitor can save us $2 a pop. Are you willing to match his price?"
Fred could not. TruckMaster changed switch providers and, low and behold, the new components started to fail. TruckMaster found itself sending out heavy-duty tow trucks, to the tune of $350 each time, to replace a $4 part. It doesn't take a math genius to realize that the $2 cost savings was getting eaten up quickly. So TruckMaster's service/warranty repair people started voicing complaints and before long, Fred was back in business.
The story above is true. It illustrates what can happen when a company's purchasing department is driven to achieve its goal (lower acquisition costs) with little or no regard of the value impact on other areas of the company. The point of this story is that the truck manufacturer allowed purchasing to make a decision that the service/warranty department knew nothing about. The purchasing agent was honest; what happened down the road really wasn't his concern. He was paid to lower acquisition costs and he did his job. It's too bad his decision was detrimental to the company's bottom line.
Shortsighted decisions by cost-focused purchasing departments are not uncommon. Purchasing departments can cause two major problems for an organization. First, purchasing is incented to save dollars of cost, a mandate that too often means dollars of value are lost. Second, purchasing often operates by obsolete and counterproductive rules--specifically, the "x number of bids required" or "create a level playing field" rules that pit vendors against each other with the intent to drive the price down. It does, but the net effect of creating a level playing field is that along with inferior solutions, solutions with high value are systematically eliminated from consideration.
So what can companies do to ensure that their purchasing procedures are not undermining other departments by diluting value and ultimately bringing down profits? Here are some points to consider:
Make sure procurement incentives do not overpower other functional interests. A purchasing department with too much power will gravitate to the lowest common denominator: price. Worse, it will generally not be held accountable for the value a solution delivers in business performance terms. A department that has to live with the outcome of a purchasing decision will more likely have a better grasp on the big picture and an eye on the bottom line.
Don't approach buying complex solutions like raw materials. It strips value from solutions. When you buy something that has a variant in quality or capability, like consulting services, complex components, or software, commodity purchasing procedures begin to impinge on the value, especially when support given by the supplier is a critical ingredient to the success of the product or service itself.
End the five-bids charade. It may lower price, but it also dilutes value. Somewhere along the line companies believed that to purchase properly they must collect a certain number of bids and then pit multiple vendors against each other. By forcing their preferred vendor to compete with others, they believe they can drive the price downward. This usually backfires.
If your vendor relationship isn't broken, don't fix it. If you have a superb relationship with a vendor who understands your business, is well equipped to do the job, and has a successful track record, hang on tight. Don't bid out your next project to someone who might be a few dollars cheaper, or worse, ask your great vendor to match a competitor's price. Not only do you risk losing a valuable business partner, you end up delaying projects and squandering your own time and resources, or forcing your valuable business resource to take out some of the value you require.
Give your vendors the information and people access they request. Strong business relationships and the value-laden solutions that come from them don't happen magically. They can't develop until you allow suppliers to diagnose your problems and work closely with your team to develop valuable solutions. That means you must allow vendors access to the people in the appropriate departments. However, if you have a vendor who doesn't bring you a thorough decision process for understanding your situation, who can't speak in financial terms, or who can't show you a return on investment for his solution, move on to a resource that can.
Salespeople need to do a better job of helping their customers understand the value of their solutions. If they are selling on price, purchasing agents can hardly be blamed for buying on price. The key is for you and your vendors to work together to discover where your products are falling short and design solutions that can optimize your business performance. By changing the way you buy, by ceasing to reward your purchasing department for chasing the lowest price, you will allow your vendors to bring you valuable solutions that can give you a greater competitive advantage.
About the Author
Jeff Thull is president and CEO of Prime Resource Group. He has designed and implemented business transformation and professional development programs for companies like Shell Global Solutions, 3M, Microsoft, Citicorp, Intel, IBM, and Georgia-Pacific, as well as many fast-track startup companies. He has gained the reputation for being a thought-leader in the arena of sales and marketing strategies for companies involved in complex sales. He is the author of the best-selling book Mastering the Complex Sale--How to Compete and Win When the Stakes are High and the newly released The Prime Solution: Close the Value Gap, Increase Margins, and Win the Complex Sale. Please visit Prime Resource Group. Or call Jeff Thull at (800) 876-0378 or (763) 473-7529.