Using Economics and Political Theory to Explain Procurement Failures

Spend Matters welcomes a guest post from Biju Mohan of GEP.

In Why Nations Fail: The Origins of Power, Prosperity and Poverty, Daron Acemoglu and James Robinson develop several hypotheses to explain why poor countries are poor. These explanations can be summarized as below:

  • Presence of extractive institutions / Lack of inclusive institutions
  • No tolerance or encouragement of “creative destruction”
  • Lack of resoluteness towards retaining inclusive institutions

Using economic and political history and detailed data, they have provided evidence of the impact of all the above reasons on the prosperity (or lack thereof) of countries and regions.

By now, you must be wondering what this has to do with procurement. After reading this book, I realized that these hypotheses can also be used to explain why some procurement departments do a stellar job of generating value for their companies while others abjectly fail.

Presence of extractive institutions / lack of inclusive institutions

Have you ever entered a one-sided contract where you feel that you are being fleeced by the other party? Yes, I am talking about multi-year cell phone contracts or credit card fee agreements. The same holds true for many supply contracts that procurement signs with suppliers. Many procurement professionals believe in extracting the most out of supplier relationships by beating down the unit price of goods and services. Suppliers are viewed as whipping posts to flog and extract savings. Suppliers most often sign up for these agreements to retain their incumbent position or to gain an entry into the buying organization’s business. However, what many procurement folks fail to realize is that such relationships, by nature of being “extractive,” cannot be sustainable. Very soon, suppliers realize that it doesn’t make business sense for them and start padding their invoices with hidden costs or worse, by compromising on the quality of the goods or service.

A bio-technology company realized recently that the new suppliers providing them plastic components at 75% of current costs were, in fact, scrimping on quality control to reduce costs – resulting in higher in-plant rejection. What resulted were higher processing costs because of additional material required to make up for the higher rejection rate. Pretty soon, the contract with this supplier was annulled and the company went back to their original contract – less extractive and better for both parties.

No tolerance or encouragement of ‘creative destruction’

History has shown that the world has progressed primarily through unforeseen, non-linear, step jumps in technology and ideas, or “creative destruction.” The success of these ideas depend on challenging the status quo – hence the “destruction” in “creative destruction”! For example, there are likely apocryphal stories of Fred Smith getting a C for a paper he wrote about a business idea for overnight delivery of packages (the paper was implemented in the form of FedEx). The professor was of the opinion that nothing could challenge the dominance of USPS.

Suppliers are often the best positioned to come up with improvement ideas that can make the buying organization’s business more efficient and hence, cost effective. These ideas, taken in the right spirit, can go a long way in improving your business processes.

The best procurement organizations realize this and actively encourage their suppliers to suggest game-changing ideas that will transform their business. Unilever, for example, has joint process improvement workshops with their packaging suppliers. Some of the ideas developed in these workshops include doing away with packaging QA at the factory, redesigning of the packaging for bulk materials, use of higher strength corrugated for shipping cartons, etc. The result? Unilever gets world-class packaging at competitive prices while suppliers are able to leverage Unilever’s know-how to improve their competitiveness and become more successful.

Lack of resoluteness towards retaining inclusive institutions

Anyone who has dieted or followed a fitness regimen will attest to the fact that it is very easy to quit.

Many organizations have attempted to set up joint process improvement teams with their suppliers. They have organized supplier conferences to solicit ideas from suppliers, but these have been followed by half-hearted attempts to implement them. Many of the ideas don’t translate into results!

This is primarily due to lack of support for these ideas at all levels of the organization. Any such initiative needs to be supported by the top management, communicating a clear message to the organization and their partners that these approaches are strategic in nature and need to be taken seriously.

For more interesting thinking on procurement, visit the GEP Knowledge Portal.

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