In many cases, organizations continue to make purchasing decisions based on price. It has been baked into their DNA, with the mantra of ‘commoditization’ backed up by software that drives price-based competitive auctions and measurement systems that continue to monitor ‘negotiated savings’. In the public sector, this is further reinforced by public procurement rules that blithely ignore concepts of value and have failed to adapt to the nature of today’s supply requirements.
Many claim otherwise
Suggestions that procurement decisions remain focused on price are often met with howls of protest and claims that such an approach is a thing of the past. In some cases, this is true – there are Supply Management groups which have moved on and many who advocate the need for change. Yet supplier experience continues to attest that those who have actually changed are very much the exception.
Why is this a problem?
Simply put, purchasing decisions need context and it is rarely true that price is everything. The commoditization craze that came with reverse auctions and spend management discouraged the use of economic judgment – essentially, it resulted in economic illiteracy. A great example of this was cited in a recent edition of Talking Logistics, which examined the influence of networked technologies on the logistics industry. It made the point that, during the dot com era, many believed that they could convert a traditional relationship-based industry into a spot market commodity. They were wrong. The article highlights how similar efforts are now appearing as a result of digitization. In both cases, these are driven by the hunger for lower prices, but illustrate two fundamental misjudgments:
1) creating a spot market does not necessarily alter the availability of supply and is more likely to reduce competition over time than to increase it;
2) low prices frequently do not translate to low cost. For example, reliability and quality of collection, shipping and delivery frequently has far greater importance than saving a few dollars in processing costs. A failed delivery may well catch the CEO’s attention; a nominal ‘saving’ certainly will not.
So what’s the answer?
Procurement decisions need context. They must examine impacts that stretch beyond the acquisition and explore downstream effects. I recall a great story from the public sector, where a buyer thought it would be a marvellous idea to save money in the criminal justice system by supplying gaols with fruit that had failed the supermarket tests of homogeneity. It seemed entirely logical – saving money and the environment – until it caused a prison riot due to the inequitable size of portions!
With the growth in the scale and types of acquisition, in particular the shift towards services, procurement decisions need a new and economically-based approach to sourcing decisions and supplier management. ‘Price’ must be put in its proper place – and my next blog will expand on how that should be achieved.