Today, I’d like to welcome back Supply Excellence guest blogger, Doug Smock. Co-author of the supply management best-seller, Straight to the Bottom Line, Smock will continue his findings on new strategies and systems for product should- and future costing.

In a recent post on Spend Matters, Jason Busch briefly reviewed a CAD-based costing technology from a start-up that has partnered with Caterpillar to commercialize an automated tool for analyzing castings’ costs. Jason asks: “might this type of approach ultimately become the bridge between the procurement and design functions?”

It’s a good question because I’m glad that people are at least recognizing the need for better integration of supply and design. Bad question because it’s the totally wrong way to approach this monster issue. Best-in-class companies are completely redesigning the way that design and procurement interact at a very fundamental level.

Why?

1. Because 80% of a product’s costs are locked in by the time it reaches the CAD phase.
2. Almost 90% of the time it takes a product to get to market is consumed in produce planning and design
3. Because excessive product complexity can balloon costs, bloat inventories, and slow responsiveness to major shifts in demand.

Companies have typically designed new products the way they bought components to make them. That is, in a very decentralized environment where engineers made specific choices each time they were engaged in a design. They had no access to data on previous types of products specified or sourced that could have been re-used. There was no effort to develop commonality or leverage that commonality with strategic supplies. Or even to bring those partner suppliers into the design phase.

One of the first companies to change was Harley Davidson, which nearly went under in the 1990s because engineers were kings of the show. Their products were no longer cost competitive. And not always the best. HD established an office of product cost and created a program of resident supplier engineers who would help on innovation. Companies such as Lucent and IBM now report metrics on how many specified products and systems are based on a pre-approved list. Supply managers play an important role in these project development committees. All of the data development and information-sharing fits into the field of product life cycle management, which is a business process. There are software tools that make the process easier and more seamless.

Once that is in place, you need to look at the fit for should-costing analysis. Again, this is first a process. It’s a way of understanding costs and making sure that your suppliers and your internal manufacturing processes are best-in-class. It’s a better way of developing costs than constantly putting business out to bid in electronic reverse auctions. Auctions have a role in a sourcing process, but not as a costing tool, which as I mentioned in my previous post, happens way too often.

More on should-costing in my next post. Incidentally, for my news reports on some costing solutions and approaches, check out: http://globalcpo.com/_wsn/page3.html.

AMR rode into the On Demand/Sofware as a Service (SaaS) debate last week with its guns loaded with much-needed frameworks for evaluating SaaS solutions and measuring success of providers in this rapidly emerging enterprise application model.

In one of his first notes on the subject, AMR’s new resident SaaS wrangler, Robert Bois, got beyond the speculators and took aim at the fact that On Demand and SaaS models are inherently different than traditional installed applications. Because of this, the industry requries new metrics for measuring SaaS solutions and provider success.

“[SaaS] has created a new culture within the software community where customer service, user adoption, and easier implementations are the new gold standards,” wrote Bois. “Metrics formerly regulated to the likes of telecommunications companies now pervade the software industry — total contract value, customer retention, and churn rates.” He adds that this is good news for enterprises because it forces solution providers to “put a new premium on customer satisfaction.”

Bois recommends that enterprises adjust their evaluation criteria for SaaS solutions as well. In addition to functionality, Bois suggests that enterprises scrutinize On Demand solutions in the following areas:

• Pricing models (is it user based? is there a startup fee?)
• Service level agreements (is there one and are there explicit rebates?)
• Customer support (is it included in the monthly fee and how comprehensive is it?)

Bois also puts to rest some common misconceptions about SaaS. “While many early SaaS deployments started out as temporary fixes, AMR Research hasn’t found many companies that then dropped their On Demand for on-premise software deployments.”

On a personal side note, I’m glad to see AMR take up this issue. Over the past three months I have challenged all the leading analyst firms to introduce new measures that more accurately reflect new On Demand models. (I even had a personal sit down with AMR President Tony Friscia on this issue.)

My concern? After viewing technology market assessments from both AMR and Forrester, I was concerned that they were measuring and penalizing vendors based on outmoded attributes, such as “percent of revenues from database sales” and “percent of revenues from system integration services.” On Demand and SaaS models eliminate the need for these unnecessary burdens and costs.

Kudos to AMR for embracing the fact that On Demand is shaking the architecture, pricing, and service models of traditional software. (Bonus points to AMR for dedicating a complete practice to SaaS and On Demand.) We’ll keep a hopeful eye out to see if other analysts follow suit.

Today, I’d like to welcome a guest blogger to Supply Excellence. Doug Smock is the co-author of the top-selling supply management book, Straight to the Bottom Line, and heads up his own online community for sharing supply strategy, GlobalCPO.com. I encourage you to sign up for Doug’s free newsletter, How Smart People Buy.

A lot of supply managers talk the talk on supplier relationships, but I find that very few walk the walk. Evidence of this was the mad rush to electronic reverse auctions. One member of the Purchasing magazine Editorial Advisory Board even told me he used auctions as a tool to gauge weekly changes in electronics prices. The real problem of course, is lack of top-level metrics as I mentioned in an earlier discussion on Supply Excellence.

We need to get the focus off of short-term, short-sighted cost savings and on to longer-lasting, more meaningful metrics, such as the role of suppliers in generating innovation, improving new product development, reducing supply chain costs, and helping cope with huge shifts in market demand—up or down. Premier suppliers don’t want to deal with customers who put the business out for electronic auction after they just made a huge investment in reducing your costs.

As I pointed out in the “Tale of Two Spenders” chapter in Straight to the Bottom Line, this was a classic strategy in Detroit. A DuPont or GE Plastics would invest in development of a whole new injection molded instrument panel and then one of the old Big Three would put the resin order out for bid, and then demand a 10% price rollback off the invoice. Detroit is now paying the price today for that strategy.

One of the key issues in these new “premier-level partnerships” (a term coined by John Paterson, CPO at IBM, whose strategy will be profiled in my next book on the role of technology in supply management transformation) is how to make sure the buying company is paying appropriate costs for the products and services it receives from the supplier partner. Enter one of the processes which I think will be one of the fastest growing in the supply space in the next five years: should- and could- costing. When I first started at Purchasing magazine in 1977, costing was pretty much limited to value engineering, although some whiz kids in the John Deere purchasing department were starting to explore activity-based costing. Well, we’re in a whole new era today. In my next post, I will describe what’s happening today in cost management — both within supply management organizations and with the supply base, which is the next frontier.

Please feel free to e-mail me at dsmock@globalcpo.com if there is a particular aspect of product and supply costing you would like me to cover.

Thanks, Doug. Costing is top of mind with most Supply Excellence readers, particularly in today’s tightening supply markets where price inflation and supply scarcity are increasingly common. We anxiously await your next installment to learn how to predict future costs and develop sourcing and supply strategies to hold down costs and assure supply.

AMR’s Supply Chain Executive Conference last month gave me the opportunity to reconnect with my old pal, Julie Murphree, founder and editorial advisor at Supply and Demand Chain Executive. While AMR’s theme of environmentally and socially sustainable supply management practices renewed my focus on these issues, Julie had been embracing the “do better by doing good” mantra in her own way.

On her folksy blog dedicated to rural life, Fresh Air, Julie has examined the practicality and business impact of alternative energy sources. Her recent interview with Richard Tolman, CEO of the National Corn Growers Association (NCGA), illustrates the intersection of how increasing demand for environmentally sound fuels (in this case ethanol) is improving the economic health and long-term viability of rural agricultural communities.

However, the interview also hints that hopes for ethanol becoming a primary energy source could be dashed ironically the same forces that are driving up oil-based fuel prices: insufficient feedstock and “refinery” capacity. NCGA forecasts that the U.S. could easily produce 15 billion to 18 billion gallons of ethanol by 2015. However, Tolman says that both feedstocks and production capacity to convert corn to ethanol at a pace to make the renewable fuel a major energy source are not yet in place.

A bigger issue slowing ethanol adoption is more basic: ethanol still costs too much for widespread adoption. A 2005 study from Cornell University estimates that the total cost for a gallon of ethanol is $4.70, counting government subsidies. Even in the face of rising oil and gasoline prices, that is too steep for consumers and businesses to swallow. And big ethanol producers, like Archer Daniels Midland, will not add capacity until they forsee a significant increase in demand.

Put simply, alternative fuels and energy sources - from ethanol to solar power - are locked in an economic Catch-22. Breaking this stalemate will require a mix of innovation that lowers the cost of the production and delivery of renewable energy sources and policy that creates the right economic incentives for both producers and buyers to increase supply and demand of these alternative fuels.

There must be something in the mental ether. On Friday, I penned a post examining how supply management could add value through alternative payment management practices. I was set to post it today (under the title, “Brother Should You Spare a Dime?”) when I came across a rant from my friend and Spend Matters master Jason Busch, lambasting the European business community for raising their torches and pitchforks against recent moves by fashion retailer New Look to extend payment terms with suppliers to 75 days. Some potentially dangerous advice in his analysis prompted me to sratch my previous post and focus on addressing my concerns.

Jason rightfully states that New Look is entirely justified to extend payment terms with its suppliers. But his post, while heavy on humor and its criticism of European labor rules, misleads readers into thinking that instituting standardized, longer payment terms is good supply management practice. It is not. Instead, elongated payment terms are merely the result of two symptoms:

1. Shortsighted and outdated buying practices that are focused on brow-beating concessions from suppliers.
2. Inefficient and often paper-based reconciliation and payment processes that limit visibility into key transactional data (i.e., POs, invoices, receipt notices, etc.), elongate payment cycles, and create an aura of angst and distrust between buyers and suppliers.

The antidote? Leading organizations are taking an active role in emerging “financial value chain management” techniques which blend supply management practices with financial analytics. In fact, my alma mater Aberdeen Group has done some of the deepest and most consistent research into the integration of supply and financial value chains. I recommend reading: The CFO’s View of Procurement and the Invoice Reconciliation and Payment Benchmark. (Rumor has it Aberdeen will be releasing a follow up to this benchmark in the coming months.)

Leading supply management techniques in this area include improved cash management and return on invested capital (ROIC) through advanced demand management, invoice reconciliation and payment, and aggressive rebate management techniques.

Consider one of the world’s largest diverisifed manufacturer that I have had the chance to work with. They have fully automated the invoice reconciliation and payment process to gain immediate and accurate visibility into their invoice reconciliation and payment process.

But that was only step one.

Now the company is marrying that intelligence with available cash and budget information. They are using advanced analytical tools to assess whether to pay a supplier early in order to (legitimately) access the early payment discounts negotiated during the sourcing process. More importantly, they are using this analysis to determine whether to offer suppliers early payment in return for additional discounts or rebates.

The manufacturer reports that this “aggressive rebate management” approach is returning discount offers of 2% to 20% — above and beyond the original negotiated price. And suppliers relationships have improved because suppliers are prefer to work with a customer that pays its bills on time, eliminating the need for costly collections tasks and resources. Suppliers also like being empowered to decide whether they want to offer discounts in return for even speedier payment.

The fact is: cash is king. And if you know how much cash you can use and are willing to part with it, you’ll be surprised at how eager suppliers are to get ahold of it. And how they will willingly offer additional concessions in return.

I want to correct any misconceptions that may have been raised by my previous posts linking supply management performance to pay scales.

True, the anectodal stories and empirical data I referenced show a direct correlation between supply management salaries and performance. What doesn’t show up in this data: Top-performers not only recruit the best talent and pay the highest salaries, but they also put all team members through rigorous training and conditioning to ensure sustainable results.

Trust me, as a New York Yankees fan, I know the benefits of buying a great team. (A fact my wife, an ardent Red Sox fan, reminds me of often.) But what has made the Yankees so great over the years is that they have balanced top-paid all-stars with great managers and a top-notch farm system. (A fact my wife refuses to aknowledge.)

How do you create a great supply management farm system? I posed this question earlier this week during a brief meeting with Dr. Joe Carter, Avnet Professor of Supply Chain Management and Department Chair at the W.P. Carey School of Business at Arizona State University. An oversimplification of his answer (no professor ever gives a short answer):

1. Train your existing team.
2. Repeat step #1.

Widely recognized supply management leaders, such as John Deere, Motorola, and Toyota have aligned themselves with leading graduate schools to develop and hone the skills of team members. Most of the top supply management graduate schools offer both standard and custom programs. Here’s a quick reference guide to some of the leading executive supply management programs:

• ASU W.P. Carey School of Business
• Michigan State University Eli Broad Graduate School of Management
• Penn State Smeal College of Business
• The Logistics Institute at Georgia Tech

Development and training helps elevate the skill sets, morale, and overall value of your team. It also helps to reinforce the use of standard procedures and fosters the exchange of best-practices between teammates. There is also evidence that training improves employee retention. (More on that subject in future posts.)

If higher pay drives better supply management performance, what constitutes higher pay? Well, the answer is it depends on a lot of factors, including title, location, education, and gender.

Purchasing Magazine and the Institute for Supply Management both offer annual salary surveys that provide a baseline into what supply management organizations are getting paid and the factors that influence salary levels.

To give credit where its due, Purchasing has been providing this service for more than 25 years. Ironically, ISM just launched its innagural salary survey this year. In addition, Purchasing’s complete salary survey results are available for free. Purchasing also offers a good historical perspective of salary trends. (The good news: supply management compensation has increased 134% since 1985, the year Purchasing launched its first survey.)

ISM offers a free salary survey summary. But you must be a member to access the complete results.

Despite these differences, the most recent returns from each organization are eerily similar. I have created a handy comparison table of average salaries by job title below (click image to enlarge):

Behind these high-level stats is a wealth of insight to help supply management organizations benchmark their pay competitiveness and help individuals determine how to move up the pay scale. Some high (and low) lights echoed in both surveys:

• Experience counts, particularly after a decade: pay variances between those with fewer than five years experience and those with six to ten years experience was minimal. However, supply managers in the field 11 -20 years, reaped a 20% pay premium over those with less than a decade of experience. Those with more than 20 years experience typically get another 20% bump in pay.
• Education influences pay, particularly the right type of education: Those with a bachelor’s degree earned 32% more than those with no college degree. And those with a master’s earned 25% more than those with only a bachelor’s degree. Those with an MBA were the top earners, followed by those with a technical degree. These findings echo those I uncovered when investigating the hiring intentions of CPOs last year.
• Pay discrimination still thrives: Both surveys found that women are still paid about one-third less than men in similar supply management roles. However, one leading indicator suggests that this may be changing. Specifically, the glass ceiling is being broken. Both studies report an increase in the number of women in top procurement and supply management roles, such as Christie Breeves, CPO at Alcoa, Theresa Metty, former CPO at Motorola, and Diane Deering, VP of Supply Chain at Alliant Techsystems, Inc.
• Performance-based pay on the rise: About 60% of supply management employees now earn bonuses as part of their compensation. Purchasing reports that the use of such performance-based bonuses has been rising steadily, up 5% in the last year alone. Financial goals and profitability are the leading bonus criteria, with cost targest and saving reductions also playing a role.

I encourage you to read the full survey results to benchmark your organization’s pay competitiveness and determine if you will need to make adjustments to recruit and retain top talent.