Don’t Just Reduce Costs — Reduce Trade-Offs!

supplier scorecard Chad McDermott/Adobe Stock

One of the most critical competencies that a supply chain organization can master is the ability to not only recognize trade-offs but to reduce them. A “balanced scorecard of supply” contains high-level performance metrics for the overall supply chain, for a spend category or a supplier:

  • Total cost (and the lower-level TCO price elements)
  • Cash (e.g., working capital or capital asset levels)
  • Delivery (e.g., perfect order performance)
  • Quality levels
  • Flexibility (in the supply chain or just qualitatively with a service supplier)
  • Innovation (which is increasingly information-based)
  • Risk (which can be its own metric or an “overlay” on the other metrics)

Progressive procurement organizations don’t just get measured on cost reductions alone — especially just purchase price — but rather work cross-functionally with stakeholders to develop supply requirements and related performance metrics needed to support their particular objectives, and then work backwards to optimize the balanced scorecard so that all stakeholder objectives are considered and optimized.

I call this “supply performance management”, which is what in turns drives “procurement performance management.”

By definition, this should entail making smart trade-offs between these various key performance indicators, and also between capabilities. For example, supply chain professionals are taught early about the trade-off between customer service levels and inventory costs for determining optimal inventory balances. Another example is the trade-off between extending payment terms to minimize working capital or taking early payment discounts. Trading off quality versus cost is, of course, another oldie-but-goodie example.

The problem here is that companies tend to merely accept the trade-off rather than reduce the trade-off. They ride the trade-offs curve rather than shift it. They play a traditional game rather than change the rules to adapt the game to the environment.

Even worse, at most organizations, various functions tend to get measured on the individual scorecard elements (e.g., procurement advocating lower purchase prices) even though other performance elements might suffer, such as finance getting measured on low working capital and high days payable, which obviously can put them at odds with each other. So, the ability to use cross-functional teaming to optimize around total supply performance is key.

Trade-offs also occur between buyers and suppliers, most notably the win/lose zero sum game that often exists. The trick in sourcing and supplier management is then to maximize economic value through collaboration and appropriate benefits sharing. For example, if buyers can reduce suppliers’ costs through buy-sell programs, supply chain finance, collaborative cost reduction projects, value engineering, supply chain planning collaboration (e.g., improve forecast sharing and replenishment lead time reduction to a point where inventory can basically be eliminated) and other areas, then trade-offs are getting reduced to optimize the whole.

The biggest trade-off reducer that addresses both internal trade-offs and buyer-supplier related trade-offs is a robust sourcing processes that explicitly:

  • Captures all requirements and includes supplier inputs as well, including the trade-offs they have to make as a business and the economics around their business and supply chain
  • Scores the requirements areas rather than using yes or no questions
  • Scores non-price factors rather than just holding them constant while running online bidding events only on price
  • Opens up a large basket rather than using prelotting and trying to outguess the supply market
  • Considers constraints in the analysis rather than making the constraints an objective.  For example, “a winner take all” bidding strategy essentially makes the constraint called “max # of winners = 1” into an objective. It’s a bad idea, especially if you’re sourcing procurement software!  Don’t source as “winner-take-all” but rather compare performance scenarios with that constraint set at different values. You may find that five suppliers is lowest cost or that 10 suppliers is close to lowest TCO but has the highest value score, especially if you want a larger and more diverse supply network to support your broader goals for innovation, localization, diversity and so on.

Of course, for this technique to work with large market baskets, you'll need expressive bidding functionality in your sourcing software to handle this “market informed sourcing” approach. (Here is a nice training video that my colleague Peter Smith did on the topic.) In other words, you increase “favorable complexity” because you can manage it well rather than just over-simplifying the solution based on old heuristics such as “less suppliers is better” and “winner takes all” and “price only reverse auctions minimize cost.”

So, the software itself is not just automating a simple process “cow path” but enables new techniques like above that weren’t possible before. And technology will also enable a new level of automated market intelligence and knowledge management that will help reduce a whole slew of existing trade-offs that currently exist relative information availability versus information value, automation versus outsourcing and other trade-offs. Procurement will need to disrupt itself using such new tools and services if it seeks a step change function to deliver greater market intelligence and insights to the business, one of many topics we will cover March 14–16 at the ISM and Spend Matters Global Procurement Technology Summit in Baltimore.  
So, learn to recognize trade-offs, and whenever you see one, look to eradicate it rather than just ride it. If you’re having trouble finding a way to do so, then look to supply markets for options.  Doing so will help your stakeholders — and help you.

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First Voice

  1. Eric Lynch:

    Great piece my friend! I couldn’t agree more with your advanced sourcing optimization being a best practice vs. “winner take all” approach, especially for procurement technologies, being a “bad idea”! Thanks for the good read.

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