Ethics in Procurement. It’s Absolutely Essential!

When Susan Avery asked me to participate in a recent My Purchasing Center webcast on Ethics in Procurement, my first reaction was “What do I know about the topic that would be useful discussing with the audience?” But as I thought more about it, I realized that this is a topic that is essential to all of us as supply management professionals and something that I have very strong feelings about. I wanted to share with you some of the things we covered in the webcast.

All one has to do is pick up the newspaper and you will see, almost on a daily basis, a number of stories detailing bad ethics and poor moral judgment. Beyond the failings of Enron, BP and the sub prime mortgage debacle, of which we are continually reminded, I picked up an internet article recently that listed the top 100 corporate crime stories of 2011 and listed only a few of them. The ethical failings ranged from FDA sanctions, poor product quality and OSHA violations, to bribery, FCPA prosecutions and false advertising and product claims. And the surprising thing is that the violators are mostly very well known, large and successful companies. So, this is a topic near and dear to all types of organizations, in the US and around the world.

I thought that this definition from Wikipedia captured the essence of what business ethics is all about. And I particularly liked the references to self-interests, profits and actions affecting others.

“Business Ethics” can be defined as the critical, structured examination of how people & institutions should behave in the world of commerce. In particular, it involves examining appropriate constraints on the pursuit of self-interest, or (for firms) profits, when the actions of individuals or firms affect others.

While doing some research on this topic, I found an interesting article in the HBR (Ethical Breakdowns: Why Good People Often Let Bad Things Happen. Harvard Business Review, Max Bazerman and Ann Tenbrunsel , April 2011) that dealt with the underlying causes of ethics failures.

• ill Conceived Goals. We all need to think carefully about how we set goals, as they absolutely do drive behaviors. If your procurement group rewards only those who achieve a certain level of savings goals without balance across other key objectives, you may create some bad behaviors on your team and push teamwork, and fair treatment of suppliers to the back burner. I can think of an instance where a very senior executive needed to get a system in place by a certain date or lose virtually their entire bonus for the year. As a consequence, the executive and team pushed ahead without the required due diligence. While they all celebrated the accomplishment, over the next 2 years they dealt with the problem with a bad plan, bad supplier and failed effort to bring up the system properly that touched many of our customers.
• Motivated Blindness. How many times do we see people turn a blind eye, when the unethical actions benefit us? It is only the highly ethical and courageous person who will push back and this is where a strong company culture of ethics and integrity will ensure you make the right business decisions.
• Indirect Blindness. We often soften our assessment of unethical behavior when it’s carried out by third parties. We all need to take ownership of the implications when we outsource or work with third parties.
• The Slippery Slope mutes our awareness when unethical behavior develops gradually over time. Be alert for even trivial infractions and investigate them immediately
• Overvaluing Outcomes may lead us to give a pass to unethical behavior. Examine good outcomes to ensure they’re not driven by unethical tactics.

ISM developed Principles and Standards of Ethical Supply Management Conduct and I believe that they should be top of mind for all supply management professionals. They address a number of critical areas that include integrity in decisions and actions, conflicts of interest, confidentiality and proprietary information and reciprocity, among others. You can access the complete set of Principles and Standards at http://www.ism.ws/tools/content.cfm?ItemNumber=4740

I always believed that we could benefit by sharing our procurement goals, supplier code of conduct and standards for behavior with our suppliers. That way it was perfectly clear what we expected from them and what acceptable behavior looked like. The profession has come a long way from the hard nosed, zero sum form of negotiations that can damage the relationship with suppliers and keep them from considering you a customer of choice and sharing their best ideas and access. Something I always talked about with our suppliers was fair price (for you), fair profit (for them). If you are working with the best suppliers who are continually learning and improving, this works and can form the basis of a long and productive relationship.

A big part of ethics rests on culture and visible behaviors. Let me finish with a couple of thoughts that make this work, in my view, at the best companies in the world.
• Focus on the social norms. Leaders need to model behaviors that make it clear that unethical behavior is outside the norm and will not be tolerated, within the company or from suppliers/partners.
• Results and the corresponding behaviors used to achieve those results are both important. Make strong ethics a part of what you interview for and key promotional criteria.
• Unequal treatment is the gateway to rationalizing misconduct. Walk the Talk as leaders as discrepancies only give employees a reason to act inappropriately in their own self-interests.
• No Yes Men allowed. Surround yourself with people with the courage to question if actions truly fit into the ethical culture and fabric of the company. It is so easy to go astray without this input.

While we may often think that high ethical standards are a given, it is an area that needs to be continually managed and monitored. I would be very interested in hearing your thoughts on this topic.

SRM, The Next Logical Step

Supplier Relationship Management or SRM is still relatively new for many companies and in many cases badly misunderstood. A simple definition is “SRM is the process of fully leveraging your supply base to ensure that you are taking advantage of the assets, knowledge, technology and deep expertise of your key suppliers.” So often, your suppliers are in a position to see your company from many different perspectives, across multiple divisions and in many cases, how you operate across many different geographies. If you have done a good job in selecting the very best suppliers, then why wouldn’t you want to engage them to the fullest extent and get their input and ideas? When I addressed suppliers participating in SRM programs I have run, I would often say to them that they know more about the particular area in which they serve our business than we do. That comes from what they do so well for our company and for many other similar customers. And I always wanted to hear what they were doing with their best customers that they were not doing with us.

The following chart from Vantage Partners, a thought leader in SRM, does a good job in defining what SRM is and is not.

srm future procurement

Along so many different parameters, the SRM view of the relationship with suppliers is based on mutual respect, trust and open and honest communications. This is a major step forward from the old school approach to dealing with our suppliers that was based on limited and infrequent communications, mistrust , coercion and zero sum negotiations. I will always remember sitting in on another company’s SRM forum with so many of their suppliers and the first words out of the CPO’s mouth were that the suppliers needed to reduce their prices by 5% across the board. You can imagine how that was received by the participants and what that did to their engagement.

So why am I such a big fan of SRM? I have seen what SRM can deliver, if done well. In those situations where you have sourced a category for many years and experienced diminishing returns, it is time to think about different ways to create value. SRM can uncover new ideas and ways in which to work with your key supplier/partners that you would not ordinarily find through the normal sourcing process. The time normally dedicated to the long and arduous RFP process can be invested in working with a select group of key suppliers, yielding incredible results, if done properly. Some of the activities and focus of SRM are:

  • Process efficiencies for the customer and supplier. This could relate to how the companies plan and interact as well as the more technical aspects of how each company operates in producing the specific goods or services. The supplier often has many similar customers and can draw on a deep body of best practices that they have seen in the marketplace.
  • New Product or Revenue Ideas. This takes Procurement to a very different place in the eyes of their company when they are participating, as they should, in driving the revenues of the company.
  • Specifications and product design. Suppliers can provide important input to specifications and product improvements and provide important resources and ideas for continuous improvement.
  • Demand management or what I like to call consumption and specification management. This involves right sizing the specifications and making sure that demand is monitored appropriately within the company. A simple example of this was the work we did in travel, making sure that our employees traveled with the appropriate airlines and on the appropriate class of service, with reservations made 15 days or more in advance of the travel to ensure that the very best rates were obtained.
  • Joint planning. So many of the inefficiencies we see in our operations and in those of our suppliers have to do with lack of coordinated planning. This is a simple activity that will ensure that each party clearly understands their commitments and timelines for delivery, to avoid unnecessary delays, inventory builds or added costs to expedite.
  • Market Intelligence. Your suppliers are a valuable source of information on the marketplace in general (sales, growth, new products, pricing, etc.) as well as for specifics on competitors.

Key components of all of these processes are a formal governance process that lays out exactly what and when you will do certain activities, a commitment to frequent and candid communications and two way feedback.

So why aren’t more companies embracing SRM? I think that many companies still see significant and measurable value through traditional sourcing and have not yet seen the pressure of diminishing returns. So many of our sourcing professionals have been measured and rewarded from the traditional activities and have a hard time devoting the time and effort to something that they are not sure will deliver value. So part of this is making sure that SRM is part of a team’s goals and objectives and making sure that you do this with a select group of suppliers who are as interested in doing this as you are. Focus on those suppliers who can have a significant impact on your business and only work on those ideas that can generate great value for both parties. And lastly, dedicate the appropriate resources to these activities across the company, and closely track your progress. Here is to SRM and to expanding the ways in which Procurement can add value to the enterprise.

A Compelling Framework for Developing Your Category Strategy

I was looking through some older presentations, thinking about a good topic for my next blog and came upon this Procurement Strategy Council (PSC) hierarchy for developing a category strategy.

psc

 

All too often, sourcing is approached in a simplistic fashion, and doesn’t look at the key elements to create the greatest value for the organization. While some of these tiers may at first appear self evident, let me share some thoughts on key activities you should pursue in developing your category strategies.

Understand Your Spend

  • There is no substitute for deep category knowledge, in creating impactful and appropriate category strategies. That usually comes from including knowledgeable internal clients on the sourcing team, including this expertise directly in your sourcing organization for your more significant categories and/or researching the category and understanding the related best practices. I have always thought that the most effective organizations had a good balance of pure procurement talent and subject matter experts, who can be trained in our methodology and negotiation skills.
  • Rationalizing your supply base has many benefits that are often not easily quantified but significant, nonetheless. Think of all the costs with maintaining your supply base: all the interactions in negotiating and managing the contracts; the complexities of your supply chain, whether that be physical or administrative; the on-going interactions of your internal clients with your suppliers; and more importantly, the lost opportunities from not creating a big enough relationship where you have some leverage, create economies of scale for your supplier, and you becoming important enough for your supplier to share innovative ideas and give your company preference in supply and service.
  • Leveraging your spend across the enterprise is clearly a major driver of value, and should be a starting point for any basic supply strategy. Unfortunately, many companies do not have the basic systems or capabilities to fully understand their spend, and as a consequence, lose major opportunities for value. And in many cases, the sourcing activities are done in more of a transactional mode, dealing with ad hoc spend, rather than standing back and looking at the entire category. By looking at the value drivers in a category and determining how to assess fair value, you can structure the appropriate contracts and take much work off your plate, allowing your teams to spend time sourcing other categories.
  • There is no better way to assess market pricing than by conducting on-line auctions. Often, your internal clients will strongly resist putting their spend up for auction, thinking that they will lose control of the decision making process, disrupt their business or damage a relationship. To counter this, make it clear that you will include in the auctions, only qualified suppliers (no shills just to lower price); that while price is important, it is only one of the criteria for supplier selection; and lastly, that the selection of the ultimate supplier rests with the client, obviously with input from the project team that includes client and sourcing representation and is guided by objective criteria for evaluating and selecting the supplier. My experience has been that by using auctions, an incremental 10-20% cost reduction is possible and it can reduce sourcing and negotiations time by as much as 50%. These savings in time are important in and of themself.

Understand Your Total Costs of Ownership

  • That starts with understanding the needs of your internal clients and making sure that you have the appropriate specifications for the spend. All too often, your client will assume that they can get the very best of everything, not understanding the cost and supply implications of over specifying their needs. I have seen good programs of managing specifications and demand (usage) at companies where 20-30% of the cost could be taken out as a direct result of these efforts, without even addressing basic pricing.
  • There are so many hidden costs to consider beyond simple unit costs. Clearly, you need to look at maintenance costs, obsolescence, usage rates, quality, etc. But also consider your company’s hidden costs in interacting with and dealing with the supplier. Is the supplier delivering the best quality and dealing with customer service issues in an efficient way that eliminates work for your company? Or is it a constant chore to get the supplier to perform in the way you expected when you signed their contract? And also consider upstream and downstream costs. Are there other subassemblies or related services that should be sourced with this spend, that create other efficiencies if bundled? I have seen much out-tasking vs. outsourcing that deals with individual components rather than the full spend, that miss significant sourcing savings for the company.

Understand Your Supplier’s Industry and Economics

  • Modeling “Should Costs” can often give you a very different reference point for what a product or service should cost, eliminating the grounding that often happens when simply looking at past costs. I can remember my group looking at cans for infant formula, using this approach. What started as shock and incredulity by our suppliers, quickly turned to acceptance of some starting points, upon which we put a fair profit margin. This was one of the largest sourcing gains for this division, paving the way for more closely partnering on other spend categories. You may find that the supplier you are using is charging you a fair price based on their cost, but they may not be competitive in the industry, a good sign that a supplier switch is necessary.
  • Your best suppliers should be committed to continuous improvement and sharing some of these gains with you. Some benefits will result from better planning with your suppliers. Bigger gains are often the result of improvements in supplier operations, and the best are often using six sigma and lean programs to do that. I often used a continuous improvement clause in our contracts. Sometimes requiring as much as a 5-7% year on year improvement when processes or the relationship was new and sometimes making it aspirational, keeping this in front of the supplier and reminding them that this parameter was part of their balanced scorecard and had implications for them keeping our business. It is amazing how often our suppliers came up with great cost and quality improvement ideas, simply because we measured them on this.
  • Gain sharing can be a powerful tool and incentive for your suppliers and can get them to perform well beyond contractual terms, which is where you want all of your suppliers. Some of the difficulty here is separating the things that your suppliers should be doing from those types of things requiring investment and expertise on the part of your suppliers. These are the types of programs that allow you to see the very best resources and commitment from your supply base, so why wouldn’t you want to reward them for that type of commitment? The key is to determine what the specific outcome means to you, ensure that the benefits are directly attributable to your suppliers’ efforts and time bound the benefits as you may go through other changes that obviate the changes made by the supplier. If there are some shared investments, you will often see both parties recouping their investments prior to some sort of gain sharing arrangement. Always keep in mind that some of these projects may benefit the supplier in their interactions with other customers, so don’t give up the farm, especially when you are putting in some of the intellectual capital.
  • Look at what is happening to profitability and growth in the suppliers’ industry. You can do that by looking at analysts’ reports and the companies’ financial statements. Knowing a company and industry’s financial health, can give you an idea of how aggressive they will be in bidding for your business. Last but not least, make sure that as you put together your annual sourcing strategies, that you partner with your clients to get ownership and buy in. Sourcing is not something you should be doing “to” your internal stakeholders, but activities with your stakeholders to assist them in achieving their goals and objectives. Gaining that buy in and partnership will take some effort but will pay great dividends in the end.