Brexit begins

Tomorrow Prime Minister Theresa May will trigger Article 50 which will formally start the process of Britain leaving the European Union. No country has triggered Article 50 before and there remains a lot of uncertainty about its impact. As Ahsoka Tano said in Star Wars: “This is a new day, a new beginning.”

Many budget holders and buyers are looking for answers to 3 key questions: will Article 50 lead suppliers to request price increases, are these increases justified and is there an alternative?

Brexit, like any negotiation, won’t take place in isolation. Each party, in this case the UK and EU, face political and economic constraints. By examining these constraints, we can start to provide some answers.

Exchange rate

Brexit has caused uncertainty and consequently the pound has fallen by over 10% against the euro and dollar since the referendum in June. Triggering Article 50 will do nothing to alleviate the uncertainty so the pound is likely to remain under pressure.

While the pound remains low the price of imported goods and services will be high. For many buyers it is too late to hedge against the weak pound. Where possible, buyers should consider switching sourcing to the UK.

The weak pound is driving higher inflation. In June last year the retail price index (RPI) was 1.6% and last month it was 3.2%. Many suppliers will see this as an opportunity to raise prices. Only those whose products are affected by the value of the pound will have reasonable justification.

Industrial policy

The move towards populism in Britain has resulted in Theresa May publishing the green paper is called  Building our industrial strategy which states the UK government will favour growth in local markets. A similar approach is seen in the US with Donald Trump’s policy of America First.

The industrial policy will help some UK suppliers, for example, those in sectors where Britain already does well, such as the creative industries and life sciences, and align with others that everyone believes will be big in the future like low-emission vehicles and robotics. Unfortunately, it will take a long time before buyers see the positive effects of the industrial policy in supplier’s pricing.

Another aspect of the industrial policy will be increasing trade tariffs on certain imported goods and services. Theresa May has promised new trade agreements, however, little is known about which countries will be included and how tariffs will be affected.

Increasing trade tariffs will compound the effect of exchange rates on some goods and services. Items that are imported and those that comprise a high proportion that are imported, that is, goods that rely on global supply chains, will see prices increase as suppliers pass on the cost of the tariffs. Although it’s easier said than done, particularly in industries like vehicle manufacturing, buyers should consider switching sourcing to the UK.

Investment

Brexit has created uncertainty and the lack of transparency from the UK government has compounded the situation. Many organisations will delay investment until the outcome is clearer. This will weaken buyer’s negotiation position in the short run as some of the benefits of economies of scales are missed.

Laws and regulations

Many hope that leaving the EU will result in a reduction in regulations. They further hope that this will enable suppliers to produce goods and services at lower cost which will be passed on to customers in lower prices. Unfortunately for these people, Article 50 provides two years to reach an agreement so tomorrow’s event merely marks the start of a long negotiation process. Buyers will see little change in regulation the short and medium term.

Nearly half of Britain’s exports go to the EU so if Britain wants to continue to trade with EU countries then its exporters will have to continue to follow their rules. Through the process of “flow-down” buyers will have include elements of EU regulations in their specifications if they want to sell these items in the EU.

The UK government intends to import all existing EU rules into British law via a (misleadingly named) Great Repeal Bill. Any unwanted regulations will be abolished only gradually.

Industries that are heavily reliant on trade with EU nations, such as food, will see little change for the foreseeable future.

Public procurement

Public procurement is worth about £240bn pa or about 20% of GDP. It is governed by the EU procurement rules, for example, all government bodies have to competitively tender any contract worth over €135,000.

Many procurement professionals in the public sector do not like these rules because they ignore key factors such as the size of the organisation’s supplier spend, the category of spend and existing supplier relationships.

It’s reasonable to expect some of these rules will be abandoned and for public procurement to take a more commercial, less rules based, approach.

Competition

The EU’s Competition Commission has been active in challenging multi-nationals that have tried to exploit a dominant market position such as Microsoft and General Electric.

The EU’s economy is more than 6 times bigger than the UK economy and therefore has a stronger negotiating position. It is reasonable to assume that the UK alone will not be as effective and therefore prices from certain dominant suppliers will increase.

Conclusion

Triggering Article 50 is an important milestone for Britain leaving the EU, however, Brexit is already having an effect on procurement through the weak pound. Once the formal process to leave the EU begins tomorrow the impact will be felt in different ways and at different times in different parts of the economy.

On the one hand, the price of some locally made goods and services will reduce in the long term as regulation is loosened and the industrial policy encourages growth of local suppliers. Furthermore, the public sector will benefit from a more commercial approach.

On the other hand, the price of some goods and services from the EU will rise as the UK government imposes import tariffs and global suppliers take advantage of their dominant position. Both private and public sector organisations will delay or cancel investments whilst uncertainty about Brexit remains.

The final word goes to Carrie Fisher, another cast member from Star Wars and who died recently: “Everything is negotiable. Whether or not the negotiation is easy is another thing.”

Building our industrial strategy

Theresa May announced her industrial strategy last week. The green paper is called  Building our industrial strategy is a response to Brexit that “will help to deliver a stronger economy and a fairer society”. We have already seen signs of the government encouraging development and growth through the approval last year of £18bn for Hinkley Point C and the more recent approval of £31bn for the manufacture of four replacement submarines for Trident.

Governments have a mixed record on industrial strategies. Success of Japanese colonies such as South Korea have been attributed to the centralised state development that it had used to develop itself. Many of these domestic policy choices, however, are now seen as detrimental to free trade and are limited by various international agreements such as WTO, TRIM and TRIPS.

The government’s strategy is built around 10 pillars and suggests a greater willingness to use public money for investment in infrastructure, research and development alongside a commitment to regional development through devolution of powers to city authorities. It also includes that perennial problem child of public sector procurement which the strategy will ensure “drives innovative new products and services, strengthen skills, develops UK supply chains and increases competition by creating more opportunities for SMEs”.

So what does this mean for procurement in UK?

Like Brexit (see my blog last month called 2016 and Brexit), the effects of the industrial strategy will be mixed. It may help sectors where Britain already does well, such as the creative industries and life sciences, and align with others that everyone believes will be big in the future like  low-emission vehicles and robotics.

Brexit will be used to relax the much-disliked public sector procurement rules and the strategy will further encourage a more commercial approach.

But, alas, most procurement professional in the private sector will not be touched by the industrial strategy and will have to manage the effects of Brexit without government support.

2016 and Brexit

For many, 2016 will be remembered as the year Britain voted to leave the European Union. Since the referendum in June there has been much talk about Brexit but little information on the ways it will effect individuals and organisations. Like any negotiation, however, Brexit won’t take place in isolation and each party has political and economic constraints.

Although we may not be able to say much about the negotiation we can identify the constraints and see how these will affect the outcome with particular reference to procurement professionals.

Laws and regulations

Nearly half of Britain’s exports go to the EU so if Britain wants to go on trading with with EU countries then its exporters will have to keep following their rules.

The UK government announced that they plan to import all existing EU rules into British law via a (misleadingly named) Great Repeal Bill. Any unwanted regulations will be abolished only gradually.

Industries that are heavily reliant on trade with EU nations, such as food, will see little change for some time to come.

Public procurement

Public procurement is worth about £240bn pa or about 20% of GDP. It is governed by the EU procurement rules, for example, all government bodies have to competitive tender any contract worth over €135,000.

Many procurement professionals in the public sector do not like these rules because they ignore key factors such as the size of the organisation’s supplier spend, the category of spend and existing supplier relationships.

It’s reasonable to expect some of these rules will be abandoned and for public procurement to take a more more commercial, less rules based, approach.

Trade tariffs

The move towards populism in Britain has resulted in the Prime Minister, Theresa May, hinting that she will introduce an industrial policy which will favour growth in local markets. A similar approach can be seen in USA. One aspect of the industrial policy will be increasing trade tariffs on certain imported goods and services.

Trade tariffs will raise the cost of imported goods and those goods that comprise a high proportion of imported goods, that is, goods that rely on global supply chains.

Competition

The EU’s Competition Commission has been active in challenging governments wishing to fund large private companies, for example, the French government providing aid to Electricité de France, France Télécom and Alstom. It has also taken on multi-nationals that have tried to exploit a dominant market position such as Microsoft and General Electric.

The EU’s economy is more than 6 times bigger than the UK economy and therefore has a stronger negotiating position. It is reasonable to assume that the UK alone will not be as effective and therefore prices from certain suppliers will increase.

Investment

Brexit has created uncertainty and the lack of transparency from the UK government has compounded the situation. Many organisations will delay investment until the outcome is clearer. This will weaken buyer’s negotiation position in the short run as some of the benefits of economies of scales are missed.

Conclusion

Brexit will have a significant impact on procurement but the impact will be felt in different ways in different parts of the economy.

On the one hand, the price of locally made goods and services will reduce as regulation is loosened and the industrial policy seeks to encourage growth of local suppliers. Furthermore, the public sector will benefit from a more commercial approach.

On the other hand, the price of some goods and services from the EU and USA will rise as the UK government imposes import tariffs and global suppliers take advantage of their dominant position. Both private and public sector organisations will delay or cancel investments whilst uncertainty about Brexit remains.

The final word comes from Carrie Fisher, the actress that died earlier this week: “Everything is negotiable. Whether or not the negotiation is easy is another thing.”

SaaS: less banging and more touchy feely

If you wish to transform your organisation’s procurement capability then the answer may be to invest in a new source-to-pay (S2P) solution. There are a few enterprise software solutions – where the software is installed on your organisation’s servers – still available. By contrast, software-as-a-service (SaaS) or cloud based solutions – where you “rent” the software which is hosted “in the cloud” and accessed via the internet – are numerous.

The spectrum of SaaS is wide from Coupa which offers spend management only to Oracle which offers, well, almost everything (for a price).

So how is a SaaS different? Here are four distinguishing factors:

  • Consumerisation: unlike enterprise software, SaaS is a multi-tenant environment where the processes have been consumerised to meet the needs of many organisations. Customisation is simply not possible which means that your organisation must change the way they do things to fit the SaaS process
  • Reporting: creating reports requires a scan of the entire database.  SaaS tends to limit the kind of reporting available
  • Installation and upgrade: for a typical SaaS offering, the database software itself is installed and ready to run the instant you sign the contract. But don’t be fooled because there is still a lot of work by a systems integrator (SI) and the customer on data conversion, configuration and training
  • Price and cash flow – SaaS offerings spread the cost over the lifetime of the solution, for example, 7 years

SaaS offers procurement significant benefits, including:

  • Greater spend under management, improved savings and higher compliance through a more integrated end-to-end process
  • A more connected network of buyers and sellers collaborating and sharing real-time data
  • Greater options for financial management of the supply chain that can improve working capital and reduce cost and supply risk

These benefits will not be delivered on their own:

  • To drive adoption, Procurement must understand the human interaction points and ensure that everyone does their bit. Furthermore, there is much greater use of standardised catalogues and documentation. Change management skills in Procurement will be critical to success
  • Procurement must align its roadmap with digital and mobile within the whole organisation. Most business users will ask for mobile approvals, mobile time and expenses, and more hands-off processing. Procurement will have to become tech savvy
  • While the systems delivers the processes, Procurement will be required to analyse a much greater volume of data and deploy a variety of techniques to drive performance. Procurement’s role will be less banging the table and more touchy feely where communication, facilitation and project management are key skills

SaaS will disrupt traditional procurement strategies. Furthermore, it will demand new skills. But the rewards will be significant.

The long and short of contract theory

My interest in the Nobel Prize for Economics was piqued when I heard that it had been awarded this year for work on contract theory. Like many procurement professionals, I’ve spent many long hours in meeting rooms with suppliers trying to get agreement on terms like liability, liquidated damages and payment. My training on contracts has been restricted to legal training and has ignored economics.

Since much of procurement strategy is driven by economics, what insights does contract theory provide?

Much of my research on contract theory has lead me to ask “so what?”. A “complete contract”, for example, “is one that describes the legal consequences of every possible scenario.” Clearly, this is impossible to achieve and therefore has little practical value. Academics say that they are not trying to provide definitive or unique answers but enable us to think clearly about the issues involved. This may be useful in a lecture hall but would be given short shrift by internal stakeholders and lawyers during a high pressured supplier negotiation.

Most contracts in the real world are incomplete and the Nobel laureates, Oliver Hart and Bengt Holmström, spent their time developing something called the principal agent theory. Hart’s work focuses on finding out whether services should be run by the public or private sector. Holmström’s work focused on the ways to motivate employees. Neither of these apply to supply agreements but some of the principles can be used to provide insights for procurement professionals.

Research, for example that summarised in Popular Science Background, provides two areas of contract theory that can be adapted to improve contract drafting and drive better performance. Firstly, understanding how performance can be rewarded in ways other than payment and secondly, developing a framework to drive overall contract performance.

Improve performance without paying for it

A key part of negotiating commercial contracts is defining who has the right to decide what to do when the parties cannot agree, for example, renewing the contract at the end of the contract duration. The party that has the right to decide has more bargaining power and therefore the opportunity to drive more value from the relationship. If the supplier, for example, has the right to extend the contract then they may invest more in the relationship, for example, by improving process efficiency or identifying ways to broadening the scope of work. In this way, allocating decision rights becomes an alternative to paying for performance. For those procurement professionals judged on savings, trading the right to decide for lower prices may deliver a better outcome.

Payment linked to information about actions

Paying suppliers for performance in high risk industries, such as the supply of commodities, runs the risk of rewarding them for good luck and punishing them for bad luck. There are two implications: firstly, it is better to reward suppliers for information about actions; secondly, payment structures should be developed in a way that takes the market into account.

A supplier who correctly anticipates an increase in cost, for example, due to an increase in the price of raw materials or an over-run by a contractor and who takes mitigating action should be better rewarded than one who unexpectantly benefits from the reduction in cost. This requires a more sophisticated contract and contract management process so may only apply to high value contracts.

To avoid rewarding or punishing suppliers based on luck, payment to suppliers in high risk industries should be more biased towards a fixed fee structure. Payments to suppliers in more stable environments should be more biased towards a performance measure.

“If you can’t measure it, you can’t improve it”

There are many adages about measurement and improvement such as the one above by Peter Drucker, the management guru. Contract theory, however, shows us that there is a risk if such adages are followed blindly.

Most supplier contracts consist of many different tasks, some of which may be difficult for the buyer to monitor. To deter suppliers from concentrating on tasks for which performance is easier to measure, it may be best to offer weak overall incentives. For example, if a supplier’s payment is dependent on (easy to measure) timely delivery then quality may slip.

Conclusion

I don’t think contract theory is going to change the way procurement professionals negotiate contracts but it provides us with some extra tools to help us get a better outcome.

Any colour so long as it is black

“Any customer can have a car painted any colour that he wants so long as it is black” stated Henry Ford in 1909 about the first mass produced car, the Model T. Simplifying products enables quality to improve and cost to reduce. As part of a demand management strategy, procurement professionals apply this maxim to most products and services. Software is purchased “out-of-the-box”, “white-label” products are available in the consumer goods catalogue and “non-branded” items are promoted as part of the office supplies contract.

If you have purchased a new car recently, you will know that most manufacturers offer a bewildering array of options, not just colour. Fuel type, engine size, interior trim, driver safety equipment must be configured before an order is placed. The automotive industry provides a single platform and then allows customers to create the final product to suit their particular needs.

The automotive sector has lead the way for the procurement profession in many ways through the adoption of just-in-time management or kaizen. The pressure of delivering extra savings should not prevent us offering our internal stakeholders a choice for items that are important to them. But this is not new, after all, despite what Henry Ford said, he still offered the Model T as a 2-door, 4-door, roadster, town car, pickup and sedan in fire engine red.

The secret to eAuctions

The pros and cons of eAuctions have been debated since the technology was launched in 1990s. Michael Lamoureux, the Editor-In-Chief of Sourcing Innovation has recently added some weight to the argument against with a white paper called  The Dangers of e-Auctions.

In summary, he argues that e-auctions:

–     Don’t capture lowest cost

–     Don’t ensure quality

–     Don’t split awards optimally

–     Increase risk

He goes on to argue that eAuctions lead to:

–     Market shrinkage

–     Relationship souring

–     Increased disruption risk

I’ve managed a number of eAuctions over the last 15 years for a variety of products ranging from stationery to complex telecoms equipment. Furthermore, I’ve managed eAuctions both as an employee and as an external consultant rewarded on the basis of a percentage of the savings.

Managing eAuctions is one of the essential skills of a procurement professional. And the secret to a successful eAuction is knowing when to use it. But like any tender it is vital to get the specification right, engage with the suppliers and evaluate their responses in line with the stakeholder’s strategy.

eAuctions are only appropriate for certain categories of spend. Where the market is an oligosony and the product is a commodity then eAuctions should be the default approach. If, however, the buyer has little power and the product or service is highly differentiated then eAuction may not lead to the best outcome.

As a procurement practitioner, I have witnessed stakeholder’s excitement during an eAuction. It has not only helped drive down the cost of a product but it has facilitated the discussion about the wider adoption of procurement technology.

If Michael’s criticisms hold any weight then they are criticisms of procurement in general and not just eAuctions. Game theory and its application in the telecoms market clearly demonstrate how auctions can drive down cost. Michael’s other points about managing relationships, quality and risk are just the secrets of being a successful procurement professional.

Breakdown in procurement governance

A breach of EU procurement rules and a breakdown of corporate governance at Southern Health NHS Trust has landed the chief executive, Katrina Percy, in more hot water.

A consultancy called Talent Works Ltd, run by a former colleague of Ms Percy’s, won a tender with a value of £288,000 over three years. Southern Health paid the supplier £5.365m – an over-spend approaching 2,000%.

The case highlights the need for a procurement function which is independent from budget holders. Furthermore, it underscores the need for effective financial forecasting and contract management.

This case only hit the headlines because Southern Health has been under intense scrutiny since an NHS England commissioned a report in December that found it failed to investigate the unexpected deaths of hundreds of patients. Breakdowns in the corporate governance related to procurement is probably more wide spread than most of us care to admit.

Procurement should vote to remain

With less than a month to go to the EU referendum, most polls show that the in and out vote is split evenly with over 10% of voters undecided. Voters have been given advice from wonks, company bosses and even soldiers. So, would procurement professionals advise voter to stay or go?

There are a range of issues to consider from the cost of membership to immigration to the environment. Procurement professionals, however, are most concerned with trade and the economy.

It is worth noting that about half of UK trade is conducted with the EU. As a share of exports Britain is more dependent on the rest of the EU than they are on us. If Britain voted to leave then we would have to negotiate access to the single market.

Trade negotiations with other parts of the world are conducted by the EU, not individual member states. The EU has shown that it has the power to take on multinational organisation like Microsoft in antitrust cases.

There is little doubt that Brexit would cause an economic shock and growth would be slower. There are a range of forecasts available on the size of the shock and the impact on growth from the likes of the Treasury and the IFS. Since the assumptions vary the size of the impact also varies, however, they are consistently showing that the impact in the short to medium term would be negative.

The procurement profession should support the campaign to remain in the EU because the UK has more power as part of the EU and would avoid an economic downturn.

New systems, old mistakes

Pete Loughlin from Purchasing Insight posted a couple of great blogs this month called Things you thought you knew about e-procurement and Why big bang can be a big mistake. Both blogs deal with system implementations but highlight the importance of people and processes.

Time and again I see system implementations fail. Buying some licenses and engaging a systems integrator is only part of the solution. Speaking to the people who will use the system, explaining the benefits in a language they understand and ensuring they have robust processes in place to support their business needs is the other part of the solution.

As Henry Ford said “If everyone is moving forward together, then success takes care of itself”.

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