Is your purchasing department stripping value as it reduces costs?, Solutions!, Online Exclusives, May 2005, Vol. 88(5)

SwitchCrafter makes electronic switches that are installed in the dashboards of semis. For years, its biggest customer has been TruckMaster, which bought these vital little parts for $6 apiece. One day, the purchasing powers-that-be 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 his advice with a curt, “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 or not?”

Fred could not. TruckMaster switched switch providers and, low and behold, the new components started to fail in the field. 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—loudly—and SwitchCrafter started looking good again. Before long, Fred was back in business.

The story above is true. It happened to a client of business strategist Jeff Thull, and 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 for the value impact to other areas of the company—a classic case of tripping over dollars to save pennies.

“The point of this story is that the truck manufacturer allowed purchasing to make a decision that the service/warranty department knew nothing about,” says Thull, author of The Prime Solution: Close the Value Gap, Increase Margins, and Win the Complex Sale. “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. Too bad his decision was detrimental to the company’s bottom line.”

According to Thull, shortsighted decisions by commodity-minded purchasing departments are not uncommon. In his book, he cites purchasing as a key culprit (though by no means the only one) in what he terms “cross-functional dysfunction”—the phenomenon in which departments operate in conflict with each other.

“I have two big concerns with today’s purchasing departments,” he explains. “Most obviously, purchasing is incented to save dollars of cost, a mandate that too often means dollars of value are lost. And the other problem—which is interconnected with the first one—is that purchasing often operates by obsolete and counter-productive rules. I am speaking specifically of 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 downward.” It certainly does drive down price, but the net effect of creating a level playing field is that solutions at the high value side are systematically eliminated from consideration.

So what can companies do to ensure that purchasing is not undermining other departments by diluting value and ultimately bringing down profits? Here are some tips from Thull:

Make sure procurement incentives do not overpower other functional interests. In other words, purchasing should not be making complex buying decisions. Period. It should operate in an administrative capacity, orchestrating a quality decision process that ensures a complete value impact is reviewed. 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 almost always have a better grasp on the big picture and an eye on revenue as well as the bottom line.

Too often, says Thull, centralized decision-making equals lack of accountability. “We have a big manufacturing client that buys tons of resins every year,” he explains. “It used to be that each local plant would buy the resins it needed from the vendors that best served it. But one day the company decided it was better to buy mass quantities, so it consolidated its purchasing at corporate headquarters. At that point the people in the plants, those familiar with the service of the resin vendors and the quality and applicability of their products, were taken out of the equation. All corporate cared about was ‘how much is this resin per pound?’ Purchasing was allowed to ignore individual problems at individual plants. This is not an unusual scenario. Purchasing ignored a documented six-million-dollar value impact to capture a six-hundred-thousand-dollar cost savings.”

Don’t approach buying complex solutions like raw materials. It strips value from solutions. If you are buying raw materials—for instance, a truckload of sand—the purchasing function may make sense. Sand is sand is sand. It would make sense to have vendors place bids and then go with the cheapest one. But as soon as you buy something for which there is a variant in quality or capability—say, consulting services, complex components, or software for a new database—that same process begins to lose effectiveness and to impinge on the value purchased from the supplier. It’s always a mistake to apply commodity purchasing processes to a value-added service, especially when support given by the vendor is a critical ingredient to success.

“Think of it this way,” says Thull. “What if you had the choice of a $10 haircut or a $50 haircut? And what if someone else got to decide which haircut you must choose? Further, suppose that you are a politician, a profession in which appearance really counts. If the decision-maker were driven totally by price, he would certainly go with the $10 haircut. But in the long run, you, the politician with a bad $10 haircut, would experience the voting impact of the negative image. Your career would fail. Absurd as it sounds, there is no difference between this scenario and the electronic switch scenario at the beginning of this article.”

End the “five bids” charade. It may lower price but it also dilutes value. Somewhere along the line, companies came to believe that in order to purchase properly they must get a certain number of bids and pit multiple vendors against each other. Many corporations do this even when they already know which vendor they want to use. By forcing their preferred vendor to compete with others, they believe they can drive the price downward. Sometimes it works. Usually, it backfires.

“To compete with the lowest bidders, quality vendors must strip all the value out of their program and sell it as a skeleton, leave the value in and sell it at a razor thin margin, or simply walk away,” says Thull. “The best vendors won’t bother. Historically, the multiple bidding practice was a way to ensure that a company wouldn’t be overcharged by an unethical vendor; but like other well-intentioned plans, multiple bidding mandates have unforeseen consequences. We have reached a point where companies go through a charade that is devoid of all common sense. Everyone loses.”

If it (a vendor relationship) isn’t broken, don’t fix it. If you have a superb relationship with a vendor that understands your business, is well equipped to do the job, and has a successful track record with you, hang on tight. Don’t bid out your next project to someone who might be a few dollars cheaper—or worse, ask your 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 force your valuable business resource to take out some of the value you require.

“Strong vendor relationships are hard to find,” says Thull. “If you are paying a premium for someone’s services, chances are you should. There is a common belief that if you buy from the same person all the time you’re being taken advantage of; the truth is that they are probably looking out for you. Think back to our original example of the truck switches. The manufacturer gained absolutely nothing from changing suppliers and, in fact, it cost them money. I see this all the time and it’s amazing to see so many companies allowing purchasing to undermine their organization’s success.”

Give your vendors the access they require. Strong business relationships and the value-laden solutions that come from them don’t happen magically, says Thull. They develop over time. They cannot develop until you allow suppliers to diagnose your problems—problems that you probably don’t even know you have—and work closely with your team to develop solutions. That means you must allow vendors access to the inner workings of your company and to knowledgeable people in the appropriate departments.

“It’s amazing how many companies allow vendors only a single point of contact,” says Thull. “This is a major weakness in the purchasing process. Invite the vendor to diagnose the situation, allow access to all relevant parties, and design a solution that is acceptable. If it makes good business sense, go ahead with it. Don’t bid it out in hopes of finding someone who can do it cheaper.

“I will offer one caveat: if you have a vendor that doesn’t show you a thorough process for understanding your situation, that can’t speak in financial terms, that can’t show you a return on investment for the solution they offer—don’t work with that vendor.”

This last thought brings Thull to his final point: strong buyer/supplier relationships are a two-way street. What looks like an incompetent purchasing department may actually be the result of incompetent salespeople on the vendor end.

“Salespeople need to do a better job of helping their customers understand the value of their solutions,” he admits. “If salespeople 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 processes and products are falling short and design solutions that optimize your business performance. Your vendors should be a source of continual competitive advantage for you. By changing the way you buy from them—by ceasing to reward purchasing for chasing the lowest common denominator—you open the door that lets that happen.”

About the author:
Jeff Thull is a leading-edge strategist and valued advisor for executive teams of major companies worldwide. As president and CEO of Prime Resource Group, he has designed and implemented business transformation and professional development programs for companies including Shell Global Solutions, 3M, Microsoft, Intel, Citicorp, IBM and Georgia-Pacific, as well as many fast track, start-up companies.

Jeff is a compelling, entertaining and thought-provoking keynote speaker with a track record of more than 2,500 speeches and seminars delivered to corporations and professional associations worldwide. Jeff Thull’s work is published in hundreds of business and trade publications. He is also the author of 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.