1. everyone tries to get the hottest guy or girl they can,
2. the distribution of attractiveness of men and women follows the same curve, thus
3. the hottest couples pair off and the less hot couples settle for each other.

The reason this didn’t sit well with me, aside from dooming me to never be with hot chicks, was that, whilst couples on average tended to be similarly attractive, the evidence showed substantial variance in attractiveness. If everyone was pairing off as the theory suggested, the variance should be minimal or at least consistent across the population.

After gathering as much of the data from previous studies as I could get my hands on, I found that a different model also explained the observation that couples tend to be similarly attractive. My model was that each person has a base attractiveness requirement that, once met, permitted selection on other characteristics such as sense of humour, confidence, or skill at dancing the Macarena. This explained both the average result as well as the variance and, with dancing practice, meant that I too could one day score hot chicks.

Successful long-term supplier relationships seem to follow a similar pattern. Once the buyer and supplier are satisfied that they are receiving a demonstrably attractive price, they can then focus on other aspects of the relationship such as innovating to create additional value for their companies, investing to integrate their AP/AR systems to transact more quickly and easily etc. Conversely, selecting the supplier with the most attractive price may require forgoing other characteristics that may be more valuable to you than exceeding your base price requirements.

This is not as straightforward as it sounds because the skill with which one has purchased a product or service can only be judged relative to the price others are willing to pay. However, if I were an incumbent indirect supplier with significant market share, I would use my own customer base to provide the evidence my customers need to justify their decision to re-contract with me for another term and I’d willingly give up my ability to differentially set margins across my similar-margined mid-tier clients in the hope it would derail some of the tenders I’d otherwise be forced to participate in (assuming of course that the bulk of my profit did not arise from differentially pricing similar clients).

To do this, I’d meet with all of my mid-tier clients and, with their permission, talk about my pricing. I’d explain that I very much want to charge them all the same low price but particular idiosyncrasies in their buying patterns mean I can’t. I’d tell each of them what they can do to their own operations to allow me to service them at a lower cost. I’d summarise this in a document for each procurement manager and when she is asked to justify why she is re-contracting with me, I’d recommend that she say to her CFO, “We have been dealing with this supplier for 5 years and currently have no service issues. Our users report that they are happy with the service they are provided. I have met with the procurement managers of 5 of their other mid-tier clients and, given our idiosyncrasies, we are paying the same rates for their services as they are (and one of them took the supplier to market last year). Based on this, I recommend we focus our resources on a spend category we are less confident we are buying well.”

A couple of months ago I posted on a little experiment I conducted on sourcing music based on stated requirements. In the study I analysed the appropriateness of songs found by Pandora compared to songs played by Yahoo Music given the same requirements i.e. songs liked by a Dandy Warhols fan. I concluded that Pandora found more suitable music than Yahoo.

In my opinion, improving techniques to find vendors is not the future of sourcing. Reflecting on the best examples of sourcing I’ve seen over the past few years, I realised that they all involve the purchaser and the vendor creating a more efficient relationship structure rather than a purchaser simply finding a new vendor.

An example of a more efficient relationship structure is the vendor and purchaser using a novel distribution strategy that creates operational efficiencies for the vendor and a competitive advantage for the purchaser; or the vendor and purchaser working together to impact demand rather than unit cost. The critical feature of the more efficient relationship structure is that it is created by the purchaser contributing internal knowledge about such things as its purchasing patterns, logistical challenges and payment requirements and the vendor contributing its market knowledge to produce an item or service that perfectly fits the purchaser’s needs and the vendor’s ability to service those needs.

The future of sourcing will involve good purchasers using better techniques to find good vendors but it will also involve good purchasers and vendors creating great new products and services. As Time Magazine says of Rogers and Hammerstein “Each had already made his mark — but as collaborators they created musical theater that enchanted audiences and redefined the art form”.

I wonder what technology will enable this type of collaborative innovation?

If you cannot consolidate your spend, you must find other ways to convince suppliers to lower their prices and/or increase their services without reducing their margins to an unsustainable, sub-Beemer, level. One way of doing this is to reduce your supplier’s cost of sales. Doing this, along with reducing your cost of managing your vendors, allows you to punch far above your weight with your suppliers.

Let’s consider two companies, Big Company and Small Company, buying a non-customised widget. If the widget salesperson is willing to set their margin for Big Company so that a sale results in $1 million gross profit, they should, theoretically, be willing to reduce their margin to the same level for a sale to Small Company that nets them $100,000 in gross profit provided that sale takes 1/10 the sales effort to close and execute.

So what does this have to do with the long tail concept? Well, if there is such a thing as the long tail in procurement, the long tail calculation must include both sales cost as well as transaction costs.

Imagine you run a small procurement department managing $200 million in spend. If it is not performing well, you might make substantial improvements by throwing in some extra cash. However, if your department has lost its credibility, you can't just buy it back and, of greater concern, your contract spend will probably increase, perhaps dramatically, because fewer suppliers will tender for your work and those who do will increase their tendered margins in the belief, rightly or wrongly, that they have an advantage over other respondents. This can quickly get very expensive: For your procurement department, a 1/2 percentage point increase in contract prices means an additional $1 million in spend.

Telstra, Australia's largest telecommunications carrier, is currently facing this situation, but on a much larger scale. Unsuccessful respondents are alleging that Telstra is awarding contracts to pals of CEO Sol Trujillo without following a fair competitive-tendering process. Even if not true, these allegations may lead to higher prices through a reduction in the number of suppliers tendering for work and an increase in tendered margins.

As an example of the credibility issues, last year, Telstra retained Accenture to run a tender for a $1/2 billion billing system. The tender resulted in the selection of an Accenture-lead consortium. The other respondents, as you might imagine, are crying foul. Amongst the most vocal is Amdocs. The Australian Financial Review reports that “Amdocs is now bidding on another major contract and insiders say Telstra will be under pressure to deliver a deal.” You can bet that Amdocs will consider this when pricing their offer.

Inspired by Justin Sullivan’s article on benchmarking diapers (Thanks for pointer, Jason), I’ve decided to share the Blue Ocean Strategy lesson contained in the Golden Book, the Tawny Scrawny Lion.

The Tawny Scrawny Lion, originally published in 1952, tells the tale of a lion whose ferocious appetite results from having to chase his prey. He suggests a deal with the animals where they allow themselves to be eaten thus reducing his calorie expenditure and minimising the number of animals he’ll need to eat.

The animals (monkeys, kangaroos, zebras, bears, camels and elephants – the story must take place on Gondwanaland) are not particularly happy about this but see no other option, so they trick a rabbit into being the first meal. The rabbit entices the lion back to his place by describing his five fat sisters and four fat brothers. Upon their arrival, the rabbit and his siblings feed the lion carrot and fish soup with berries for dessert. The lion is so full after eating the soup and berries that he doesn’t eat the rabbits and comes back to their place every day for his meals rather than chasing and eating prey.

In this story, the rabbit's innovation changes the value proposition for himself and for the lion, dramatically improving both their outcomes as well as the outcomes for the broader market. Now there’s a happy ending!

I have worked in procurement organizations that were audited to insure that large contracts were bid every other year and all contracts every three years. The annual audits did not analyze effectiveness just performance against policy. Some of the groups could have been categorized as under-resourced. Most were focused on the daily requisition queue and never looked up to see if there was a better way to get things done.

The audit policy described above is not uncommon, and actually makes a lot of sense from a cost reduction perspective. The spreadsheet model shows that, from a cost perspective, going to market (a relatively easy task) is nearly as effective as managing vendors well (a more difficult task). So if a company recognises that good vendor management is a weakness and doesn't want to invest in improving their vendor management skills then going to market regularly is a reasonable fallback option. But, as most of the emails noted, companies can do better than this one-size-fits-all approach to vendor management.

What the spreadsheet model does not show are the other benefits realisable from good long-term vendor partnerships. I'm talking here about vendors who know a client's business well and can recommend changes to the client's internal processes that reduce cost or who make changes to their own systems to meet an important client's specific needs. This is a win-win situation for both the vendor and the client and generally only occurs in long-standing relationships with a high degree of mutual trust.

Technorati Tags: outsourcing, vendor management

The assumptions in the model below are that the procurement department manages $100 in annual spend. If they manage contracts poorly, their year-on-year costs will increase by 1% (Poor CM column). If they manage contracts well, initially their year on year costs will decrease by 4%, but over time, as they mature as a purchasing group, their year on year cost decreases will drop to 1% (Good CM column).

The "Poor CM" column shows the company will spend $1,281 over 12 years if they never go to market and do a poor job of managing their suppliers.

The "Good CM" column shows the company will spend $988 (23% savings over Poor CM) over 12 years if they never go to market but do a good job of managing their suppliers and achieving year on year cost reductions. A fiction, I know, but a convenient one for the purposes of the model.

The "Periodic RFT" column shows the company will spend $1,035 (19% savings over Poor CM) over 12 years if they go to market every three years and achieve the same reduction as the "Good CM" column, but do a poor job of managing their contracts and experience the same annual year on year increases as the "Poor CM" column.

This indicates that an under-resourced procurement department who cannot focus on contract management can achieve significant results simply through efficient and regular tendering.

Interestingly, if the procurement department goes to market every six years instead of every three years, the savings drop from 19% down to 14%.

Send me an email if you'd like a copy of the spreadsheet.

Technorati Tags: outsourcing, vendor management

How does this apply to vendor management? It may mean that a buyer or vendor who is getting less than they expected won't react provided they perceive as fair and equitable the process for distributing the rewards. Thus, an outsourcing relationship can remain strong even when circumstances begin to favour one party provided the mechanism for redressing imbalance is perceived as fair.

I've prepared two diagrams below that attempt to capture this relationship. The first diagram shows an outsourcing contract with a high degree of procedural fairness (clear, reasonable processes defining when and how to make changes to the relationship). The curved line shows the fluctuation in the distributive fairness (equity of effort to reward) as time passes. When the line moves closer to the top of the box representing procedural fairness (buyer line) it indicates that the buyer is putting in more effort for less reward than they expected at the outset. Note that in the diagram below the curved line does not cross either horizontal line which indicates that despite the fluctuating equity neither party reacts to the fluctuations.

The second diagram shows a relationship with a low degree of procedural fairness. Note that the inequity in the relationship fluctuates to the same extent as in the first diagram but results in two reactions from the buyer and one reactions from the vendor (a reaction occurs where the inequity crosses the top or the bottom of the procedural fairness box). In this relationship, the reduction in procedural fairness has resulted in reactions that would not have occurred in the above relationship. Note that reactions to inequity can occur in many forms ranging from litigation to underservicing.

The lesson for contract drafters is to spend time on the processes you are implementing for dealing with change throughout the life of the contract.

Technorati Tags: outsourcing, vendor management

Inside Architecture : Agile Vendor Management – removing waterfall from outsourced projects

First off, let me say that not all vendors perform all tasks. I am breaking down the tasks according to analysis, design, construction, and delivery, because it is the model that my former clients are familiar with, and because some vendor companies cannot do all of the steps. So, when reading each section, realize that each section stands alone. It can apply to a vendor hired to fulfill that role alone, or to a vendor that fulfills that role as part of a larger process.

However, if you do have one vendor creating requirements and another doing design, and potentially a third doing construction, you have to provide the facility (desks, computers, phones, server software licenses) for them to develop all of the artifacts in one place, because they will ALL be working AT THE SAME TIME.

This is absolutely key to success: the primary effort of analysis is not done until design has released an iteration and code is being delivered, and it has no positive impact if the developers don't meet, know, and trust the analyst(s).

Technorati Tags: RFT, RFP, Outsourcing, Agile development