Converting an Expense Category Into a Profit Center

 

This is a copyrighted article aurthored by Mr. Ralph Barnett.  Used by permission of the author.

 

Definition

 

Profitable Procurement is an oxymoron; a phrase that, in and of itself, is a contradiction. Predominantly, business procurement generates expenses, which are deducted from income, thereby, diminishing profitability.

 

Preoccupied with “saving money” by leveraging volume to obtain lower prices, purchasing departments neglect opportunities to add to profitability.

 

“Savings” from lower prices on expense categories such as business essentials* do not convey directly to the bottom line, if at all. Obtaining a $0.10 lower price on cartons of copy paper does not produce savings traceable to your profitability.

 

Profitable Procurement contributes quantifiable profit directly to your bottom line through an innovative strategy of “selling” procurement process improvements plus aggregated purchasing volume to a single vendor and increasing your negotiating power exponentially.

 

Let’s see how your organization can profit from an unexpected source . . 

 

 

* Business essentials encompass every product found in an organization from wall-to-wall, floor-to-ceiling: Office Supplies; Maintenance Supplies & Equipment; Technology Supplies, Software & Hardware; Break Room Supplies; Coffee & Beverage Service; Commercial Print; Furniture and Design; and, Promotional Products. Specialty classes: Mailroom Supplies & Equipment; Healthcare Products; Banking Supplies; Library Supplies; Legal Supplies; School Supplies; and, Green Products.

 

 

The Foundation

The cornerstone of Profitable Procurement (PP) is your procurement process because all benefits derive from improving this function.

 

The steps in the Procurement Process:

 

[1] Requisitioning by the enduser of the product that satisfies their need

[2] Selecting a vendor that can deliver the correct product when and where needed

[3] Pricing the product from the vendor for reference or purchase order

[4] Ordering the product from the vendor

[5] Receiving the product externally and internally

[6] Distributing the product to the end user

[7] Allocating the price of the product to the cost center or department

[9] Paying the vendor for the product

Your Procurement Process

 

The Pie Chart or The Amoeba on Drugs

 

Does your procurement process resemble the organized pie chart and save your organization money?

 

Or, does your procurement process resemble the disorganized amoeba and cost your organization money?

 


 

 

In innumerable surveys of purchasing personnel, I presented the pie chart and amoeba graphics and asked, “Which of these symbols best depicts your process?”

 

Overwhelmingly, without hesitation, buyers pointed to the amoeba.

 

A small number claimed the pie chart. When queried about specifics affecting their process, the most revealing being the number of vendors, these buyers quickly retracted their initial reaction and opted for the amoeba.

 

As an aside, when end user employees were given the choice, responses were unanimous and emphatic, “Amoeba, definitely.”

 

Author’s Note: Even in the unlikely event that your process resembles a pie chart, it still costs your organization immeasurably.

 

 

Your Vendors’ Operating Process

 

 

Paradoxically, your vendor’s operating process mirrors your procurement process and vice versa: how you perform the steps in your process directly affects your vendor’s process and how your vendor performs the steps in their process directly affects your process, adversely or beneficially. Unfortunately, and all too often, it affects your process adversely.

 


 

Despite opposing objectives, your organization and your vendor constitute a symbiotic relationship: your amoeba costs your vendor money; and, your vendor’s amoeba costs your organization money.

 

Therefore, improvements to your process benefit your organization and, reciprocally, your vendors; and, vice versa.

 

For example, when your organization orders and conducts inquiries online or purchases more business essentials from one vendor, the vendor’s operating process benefits and saves them money.

 

Mutually, when your vendor improves their fill rate, order accuracy or delivery time, your procurement process benefits and saves your organization money.

                                                                                                                                                                          

Whichever party initiates the improvement gains a negotiating advantage. Profitable Procurement tips the scales in your favor.

 

The Solution

 

Procurement Process Management

 

 

Procurement Process Management (PPM) uncovers an unrecognized cost to your organization:

 

[1A]  procurement process takes place inside your organization;

[2] The process costs as much or more than the products procured;

[3] Significantly, to save money, reduce the impact of this expense-producing process on your organization; and,

[4] Strategically, to increase productivity, re-apply the misallocated resources to the core, revenue-producing activity of your  organization; and,
 
[5] Profitably, to add to your bottom line, “sell” these improvements to a single vendor.

For example, higher fill rates on business essentials translate to less time your enduser employees spend checking on backorders, which enables them to spend more time on their mission-critical tasks contributing to profitability. Whereas, a lower price that “saves” money does not “save” your employees any time or contribute to profitability.

 

For over 35 years, speaking to purchasing personnel of every stature, rarely did one deny the existence of a procurement process inside their organization or that the process costs as much or more than the products purchased.

 

What was not rare, though, was the disregard with which they treated the impact of this process on their organization.

 

The objective of PPM is to convert the amoeba into a pie chart . . .

And, convert an expense producing product category into a profit center for your organization.

 

Your organization runs two businesses concurrently: your strategic, revenue producing business and a non-strategic, expense producing procurement process for business essentials:

 

Q. What is your strategic business, your reason for being in existence?

 

Q. Were you aware that your organization runs a non-strategic business too?

A. No.

 

Q. And, that business costs your organization?

  • Insignificantly, cost of business essentials, less than 10% of total expenses;
  • Significantly, cost of the procurement process (even if a pie chart, it still costs);
  • Strategically, incalculable cost of detracting employees from their mission critical, profit producing duties and responsibilities?

A. No.

 

Q. Does your organization have finite or infinite resources?

A. Finite resources.

 

Q. How much time or resources does your organization expend running their procurement process for business essentials?

A. Any time or resources expended in your procurement process for business essentials is toomuch because it detracts employees from their profit producing duties and responsibilities.

 

Q. How well does your organization run their procurement process for business essentials?

A. Not very well, like the amoeba; certainly, not as well as you run your strategic business.

 

Q. Does your procurement process for business essentials cost your organization (even if a pie chart)?

A. Yes, as much or more than the business essentials purchased.

 

Q. Who else runs a procurement process for business essentials?

A. Business essentials dealers.

 

Q. How much time and resources do they expend running it?

A. Full time; business essentials is their strategic business.

 

Q. How well do they run their procurement process for business essentials?

A. Better than your organization and, hopefully, as well as you run your strategic business.

 

Q. What is the goal of Profitable Procurement?

A. Converting an expense category into a profit center by improving your procurement process and “selling” the improvements to one business essentials vendor.

 

Debrief

 

Micromanaging business essentials expense by an emphasis on “saving” money through lower prices results in a procurement process resembling the amoeba and costs your organization.

 

Alternatively, micromanaging the procurement process produces a pie chart, which saves your organization money and allows you to micromanage your strategic business by re-applying employee resources to grow profitability.

 

Your Revenue Statement

Q.  How much Employee Salaries & Benefits really belongs to Business Essentials because of the onerous, transaction-intensive procurement process?

A.      As much or more than the products purchased.

Q. How many vendors does your organization use for business essential classes - Office Supplies; Maintenance Supplies & Equipment; Technology Supplies, Software & Hardware; Break Room Supplies; Coffee & Beverage Service; Commercial Print; Furniture and Design; Promotional Products and Specialty classes?

A. If more than one per class, way too many because number of vendors has most deleterious effect on your procurement process.

Q. How many checks does your organization process each month to business essentials vendors?

A. If more than one per class, too many.

 

Q. Does a lower price on business essentials improve your organization’s fill rate, lower product

      returns, increase order accuracy, improve delivery time, i.e. your procurement process?

A.  No. And, actually lower prices negatively impact these service ratios and your process.

 

Q. How much business essentials expense should be recorded as "prepaid" because of thefallacy of "buying more to save more,” which results in overstock due to erratic vendor fill rate and delivery?

                                                                                                                              

Q. Does the adage, “Time = money,” apply to your organization?

A. Yes.

 

Q. Does your organization grow profitability by buying business essentials at lower prices or does it, in reality, increase the cost of procurement and, thus, decrease productivity and profitability by a misplaced emphasis on price?

 

Q. Is your organization’s cost of procurement reflected on invoices for business essentials?

A. No, only the recognized price of products; not the unrecognized cost of the process.

 

Q. What is the true total cost of business essentials?

A. Business essentials expense plus the cost of the procurement process.

 

 

Your Unrecognized Procurement Costs Converted into a Recognized Expense

Costs are hidden or unrecognized when not included in the actual invoice price.

 

Procurement process costs are hidden throughout your organization in small, elusive increments. Because they are so diffuse, they are easily overlooked.

 

Your ability to uncover the procurement costs is directly correlated to your ability to identify your process and the participants; be a Pointillist, not an Impressionist.

 

Every end users of business essential products is an end user of the procurement process:

 

  • Primary end users are employees who perform the largest aspect of the steps in the process:

-Accounting department is wholly responsible for the Allocating and Paying steps.

-Receiving department is responsible for the largest chunk of the Receiving and Distributing steps.

-Ironically, purchasing department has the least significant responsibility in the procurement process steps. Has the least to do in the process.

  • Secondary end users include every employee in your organization and comprise the largest portion of procurement process costs.

   

 


Fallacy of the Cost of a Purchase Order

 

 

When confronted with the cost of the entire procurement process, many purchasing departments counter by proclaiming their purchase order cost.

 

This is a specious argument:

 

  1. Despite the universality of the query, “How much does it cost to process a purchase order?” there is no widely accepted measure.
  2. Considering the cost of a purchase order as a measurement for the effectiveness of a purchasing department is misleading
  3. The cost of a purchase order does not equal the cost of your procurement process. is similar to believing that the total cost of purchasing business essentials is the business essentials expense.
  4. Your purchasing department performs only a small, and ironically, the least important, part of the entire procurement activity; therefore, any calculation of the cost of a purchase order ignores significant costs.
  5. Allow purchasing departments to accept the cost of a purchase order and justify it to management as a “cost of doing business.” Consolidate vendors equals consolidation of purchase orders
  6. True cost of a purchase order, which includes the entire procurement process would prove that the purchasing department does not “save the company money” buy buying at the lowest prices but in reality cost your organization more than they purportedly save.
  7. If the cost of a purchase order meant anything, the purchasing department would eliminate their use or, at a minimum, reduced the number issued. Consolidate vendors equals consolidation of purchase orders.
  8. Cost of a purchase order spreads the cost over all purchase orders from small $ amounts to large $ amounts. Because of transaction intensity of non-critical workplace essential products, the cost of these purchase orders would be prohibitive.
  • Cost of a PO is only a small part of the external ordering step.
  • Consolidate vendors equals consolidation of purchase orders
  • Calculation of cost of PO based spreads these costs over all the POs including the large dollar purchases; the cost of O/P PO are considerably more than the average because of transaction intensity of business product categories.
  • Average order size v. cost of PO.
  • Non critical, transaction intensive category.

 

Once purchasing departments calculate the cost of their purchase orders, they accept the cost as a factor of doing business. To my appeals of process over price, I heard buyers proudly pronounce, “Well, our cost to issue a PO is  . . .!” But, I never heard them tell me how they plan to reduce that cost. Purchasing departments are comfortable with the knowledge of their cost to issue a PO . . . or they would already be implementing PPM principles to reduce the cost of the process to their organizations


Price Anecdotes

 

Cost versus Price Anecdotes

“There is hardly anything in the world that someone cannot make a little worse and sell a little cheaper, and the people who consider price alone are that person’s lawful prey. It is unwise to pay too much, but it is worse to pay too little. When you pay too much, you lose a little money - that is all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing what it was bought to do. The common law of business balance prohibits paying a little and getting a lot - it can’t be done. If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that you will have enough to pay for something better.”

Chicago Tribune, 29 January 1928

 

 

“The NCAA men’s basketball tourney reaches beyond sports fandom and deep into the American workplace through ubiquitous March Madness pools in which contestants try to predict which teams will win each of the 63 games. According to a study conducted by Challenger, Gray & Christmas, a Chicago outplacement company, if all 36.6 million Americans with a bachelor’s degree (workers who have attended college being deemed more likely to follow college basketball) spend ten minutes each day talking about the pool during the 15-day tourney, the U.S. economy loses $1.4 billion.”

 

Atlantic Monthly, June 2003, p. 37

 

This selection from my book derives from a TV commercial that artfully depicts the subtlety of process costs:

 

Ken volunteers, “Stuart, forgive me, but I’d enjoy interpreting this one, please?”

To their delight, I bow with exaggerated panache, “Far be it for me to deny my boss his chance at celebrity.”

Claudia accuses, “He wants to play Star Wars with the laser, Stuart.”

Ken upholds, “I wouldn’t have noticed, much less appreciated, this ad had it not been for your eye-opening disclosures last week. The clip portrays an employee, not just any employee, but a well-dressed one, probably one of the gazillions from the Atlantic article. The employee rests against a copier waiting for reproduction of his pages. While distracted from his real job, a hand surreptitiously reaches from the copier to pickpocket the unsuspecting employee.

"I don’t recall the commentary because the image affected me so forcefully. Essentially, a lower-speed copier embezzles money from the employee and, symbolically, from the company’s bottom line.

Claudia educes, “It blows my mind that we consciously justify a higher price for a speedier copier but unconsciously accept poor delivery of office supplies for a lower price.”

 

Procurement Process Management, a book by Ralph Barnett

 

A cartoon materializes: an astronaut squirms out of the hatch of his dilapidated capsule flying through space and screams, “One giant step for mankind -- at the lowest price.” Thanks to Marta’s last minute Internet research. Launching a giant step in my career, I lift off: “The three astronauts return from the first manned mission to the moon. They hold a press conference covered by thousands of reporters and beamed live around the world to billions. The majority of inquiries go to Neil Armstrong, immortalized for his ‘giant step for mankind,’ and others to Buzz Aldrin, his moonwalk partner.

 

A reporter notices Mike Collins, who did not walk on the moon, eclipsed by the shadow cast by the moonwalkers. When a favorable moment arises, the reporter poses a question to shed light on Collins’ intrepid exploit. ‘Astronaut Collins, while piloting the Columbia spacecraft when your mates took their giant step, what were you thinking?’

 

Collins pauses briefly to compose his thoughts before explaining, ‘While Neil and Buzz were making history, I was alone in the command module in lunar orbit, 240,250 miles from earth, in space devoid of oxygen, orbiting the moon at 3,900 miles per hour, with thousands of asteroids flitting about, protected from instantaneous death by a thin, putatively impregnable, aluminum-skinned machine -- manufactured by my government’s lowest bidder.’”

Procurement Process Management, a book by Ralph Barnett

 

On a morning flight I occupy a window seat, uncharacteristic for my lanky frame but fitting for the ensuing encounter. A thick pile of papers litters my lap as I organize them for my afternoon training session. Yeah, I hear you snickering, "Paper pages in the 21st century, Ralph? Low-tech, don’t you think."

 

To my right sits a fellow business traveler with an open laptop, but not merely any laptop, the latest high-tech marvel. Shortly after takeoff, I sense him leaning over my shoulder to check out my no-tech, dog-eared pages. His screen glows from a PowerPoint of dazzling quality as he clicks through virtual pages at hyper-speed.

 

After several sequences of peeking at my notes and fast-forwarding through his PowerPoint, he lightly taps my arm. When I turn, he exclaims with comrade-in-arms glasnost, “You must be in purchasing, too.”

 

Drawing on my experience as a public speaker, I manage an intelligible, “Uh, uh, no.”

Egged on by my obvious obtuseness, he persists, “Are you sure?”

By this time, my wits catch up with my mouth, “Yes, I’m sure I’m not in purchasing.”

Puzzled but undaunted, he seeks, “What line of business are you in?”

Equipped to handle this one, “I’m in sales training.”

He presses, “Are you independent or do you work for someone?”

“I used to be independent but now work for a national company.”

 

Finally, he discloses, “I thought you were in purchasing because your notes are similar to my PowerPoint.”

 

Teasing him with crazily crossed-eyes, he laughs easily and nods at my lap of shabby sheets and restates, “Well, the information is similar.”

 

Closing his laptop, he continues, “I’m director of purchasing for Corrugated Manufacturing and we’ve adopted a strategic purchasing program called Supply Chain Management. I’m launching the effort by traveling to our manufacturing facilities to train our purchasing personnel on our new approach.”

 

His avowal amuses me. In the 21st century, the Age of Technology, a director of purchasing introduces his Fortune 500 firm to a “new” procurement program.

 

Asked to describe supply chain, he complies earnestly. “Learning that our vendors don’t have any dollars left in the till to lower prices, we concluded that the way to save money is through process improvement. Supply Chain aims to select vendors capable and willing to collaborate to improve our processes that increase our productivity and contribute to our profitability.”

 

What he labeled Supply Chain Management, I titled Procurement Process Management. These mirror-image strategies share objectives but derive from opposing viewpoints: Supply Chain originated on the purchasing side of the desk and focuses on external factors; my method, PPM, on the vendor side and focuses on internal factors.

 

Continuing the exchange, he entreats, “Whom do you work for?”

“I’m sales training manager for Corporate Express.”

Deeper, he probes, “What are they into, transportation?”

Failure of our brand identity, again, elicits my self-effacing, Pavlovian reflex, “No, office supplies.”

He gets it, “Oh yeah, like Staples, Office Max and Office Depot.”

No problem with their brand ID draws my practiced defense, “They are retail and advertise; whereas,

"Corporate Express sells strictly business-to-business and does not advertise.”

My reply evokes a smirk and an incredulous guffaw, “You mean to tell me you’re training office supply reps on Supply Chain?”

“Sure, what’s so funny?”

Leaning closer, he whispers, “Office supplies are at the bottom of the food chain, an insignificant expense. Why not train my raw material vendors; at least they’re at the top of the food chain, strategic to our core business?”

 

Anecdote from the PPM adventures of Ralph Barnett