Imagine a new procurement officer named Jill who joined an established manufacturing company recently. She has been put in charge of her first project. She needs to purchase 1,000 pounds of Grade C Copper. It’s a commodity. She needs to guarantee its delivery to the company’s factory in North Dakota on a specific date: November 1.
It’s a simple problem. Jill’s company buys copper all the time. It has half a dozen suppliers on call. She is allowed to go only to the suppliers that her company has onboarded.
She can take the Request for Quotes form from prior purchasing events, change the dates and the amounts, and send it to each of the suppliers. The RFQ contains instructions on when and how to respond. In this case, Jill requires a quote no later than the close of business two weeks after hitting send. Perhaps she has a procurement tech solution. More likely the company just uses email and spreadsheets to manage this process.
The suppliers wait until the last minute to email their quotes. The quotes are good for a forty-eight-hour period (given the volatility in commodity prices).
Jill enters the quotes into a spreadsheet and picks the one with the lowest price. All six suppliers replied. It turns out that the vendor with the lowest bid was long inventory and had a greater sense of urgency when it came to accepting a lower profit if it meant reducing overall risk.
Pretty straightforward, right?
Under the right conditions, procurement isn’t difficult. Most of the time, procurement is a complicated business process.
Condition #1: you are a frequent buyer of the item in question. You know exactly what you’re buying. There is no uncertainty.
Condition #2: you have established relationships with a stable of reliable suppliers.
Condition #3: there is no differentiation between the product any individual vendor offers.
Putting this together, we realize that Jill is purchasing a commodity. It is a simple optimization in one dimension: price. Everything else is exactly the same.
Jill did a good job on her first task.
Now, she gets a more difficult assignment. She is put on a committee that includes the head of a couple of business units. Also present in the group are people from different functional areas including finance, product, and marketing. This set of stakeholders is in charge of purchasing a cloud migration strategy, starting with the selection of a cloud services provider and a consulting firm to manage the transition.
This project is almost the precise opposite of a commodity.
In the first meeting, the CFO sets the tone by pointing out that going with the lowest price is going to be the wrong strategy. They cannot afford to repeat what they have seen in prior “low bid” reverse auctions. A supplier with a spotty track record low balls on price to win the contract, coming in far below the clustered bids from more experienced vendors. They then proceed to fail to deliver and beg to renegotiate the price higher, claiming unforeseen and undisclosed conditions. The ultimate price ends up being much greater than what the company would have paid one of the other seasoned players. The project was delayed. The company is still working out problems, months after acceptance (and final payment).
Sometimes, picking a supplier solely on the lowest price turns out to be very expensive.
Jill learns that a complex strategic sourcing event where the Company is spending enough to move the needle on the financial statements in this period and future ones brings with it complexity. It is multi-dimensional.
What are some of the potential dimensions to consider in a strategic sourcing event?
- Competition: are we seeing enough supplier proposals for this reverse auction to be labeled a success or are we receiving only two or three substantive responses?
- Supplier reliability: can we count on them to deliver what they say, at the cost they promise?
- Problem-solution fit: is this the best possible solution for the problem we seek to fix with the procurement or will we be stuck with higher COGs or higher operating costs or lower revenue because we picked a second-best solution?
- Collaboration: is this a supplier with whom we want to build a longer-term, deeper collaborative relationship, potentially including joint innovation?
- Diversity: how much of our spending with this third-party will end up helping disadvantaged suppliers grow their capacity and capabilities?
- Price: are we seeing true competition on price or are they padding their bid?
Buyers who run multi-dimensional, complex strategic sourcing events as “low bid” auctions will get a low price, even as they bear additional risk in multiple other dimensions. The low price they pay means they are underwriting risks that their flawed approach magnifies.
We built EdgeworthBox to help companies run reverse auctions that attract real competition by making it easier for suppliers to engage with a simple user experience and a faster sales cycle. A balanced assessment of risks in an auction that discusses the full gamut of risks, not just price, will lead to better outcomes. Give us a shout. We’d love to talk to you.
