What can you do to avoid your clients’ procurement projects taking out 13% operating margin from your most profitable contracts?

How to defend your most valuable contracts from aggressive procurement strategies that could eliminate your entire profits and cash flow

There is an old story about the scorpion and the frog that were threatened by a flash flood drowning them both unless the frog could carry the scorpion to the other side of the river to safety before the flash flood arrived. The scorpion pleaded for its life to be carried to the opposite river bank. The frog responded that it couldn’t trust a scorpion who had always been trying to eat the frog. The scorpion replied killing the frog would be stupid as it depended on the frog for its survival. The frog was persuaded by this argument, asked the frog to jump on and started to swim across. Half way across the raging torrent, the scorpion stung the frog with lethal venom and with its dying breath the frog asked “why did you sting me? I’ll die and you’ll drown, why did you do that?” The scorpion replied, “what did you expect from a scorpion?”

So with apologies to all my dear friends in procurement and purchasing departments, I’m afraid these scorpions are going to go out there and attack all their major contracts looking for substantial savings. I know they talk these days about ‘strategic procurement’, ‘partnership’ and ‘total cost of ownership’ but this all boils down to taking large amounts of cost out of external spend whenever and however they can. Beware this money is most likely to come from your most valuable contracts.

Clearly procurement functions will be responding to a strategic imperative from their boardrooms. The impact of the recession on your clients’ sales and profits will put them under enormous pressures to save costs. A key client strategy will be to engage in strategic sourcing and procurement projects. What makes them strategic is the scale of the savings they are going to make from your profits and cashflow. Unless you are well prepared, the potential impact on you could be to eliminate the entire profitability of your business or worse.

Why are your most profitable contracts under threat?
Clearly during a downturn every business is fighting to protect its profitability, margins and cashflow. One of the most obvious places to make cost reductions is to look at what money is being spent on outside suppliers and how this expense can be managed down. The greater the spend within a particular supply category and the higher the margins that are being enjoyed within that category, then the more attractive the cost reduction opportunities are going to be for a sourcing/ procurement project to rationalise spending in that category. The bad news for your business is that your largest and most profitable contracts are therefore the most attractive candidates to get on a shortlist of candidates for your customer’s procurement function to target for cost reductions.

What’s the potential impact on your business?
Benchmarks savings for a typical sourcing project are around 13% (based on our experience and industry sourcing project analyses covering $190 billion of expenditure). Some categories such as Vehicle Leasing savings can be in the range of 7 to 10%, while other categories such as Travel the savings can range as high as 35 to 60%. These of course are averages, during a recession you can expect more aggressive competition to take place for contract renewals, so the target savings for procurement and sourcing projects are likely to be set higher than 13%.
Unless you are able to renegotiate a lower specification for your products and services allowing you to reduce your costs to serve (a possibility but I wouldn’t bank on it) then the cost savings are going to be made directly against your profit margins.

How will your clients go about running a strategic procurement project?
The worst-case scenario for your contracts is for your clients to run a well structured sourcing process with experienced external advisors to help them. An opportunity scan across all their spend categories can be completed in less than a month allowing them to focus on the most attractive categories (balancing savings potential against risk impact). If the first knowledge you have that the process is underway is receipt of an RFI (Request for Information) or RFP (Request for Proposal) then you are in a particularly difficult position. The likelihood here is that someone else (procurement seeking to maximise savings or even worse a competitor seeking to capture your business) has defined the evaluation and selection criteria already. Typically a sourcing project can be completed within 2 to 3 months per category, on an 8 step structured process the RFIs and RFPs are typically issued at stages 3 and 4 – so now you may only have a few weeks left to save your most profitable contracts.

What are 5 quick tips that you can use now to defend your contracts?
i) Perhaps your most valuable defensive weapon is your ‘value proposition’ and gaining clarity on how this is different and better than your competitors. You need to determine specifically how you help your clients do business more successfully. Your first starting point is the financial case, how do you help your clients increase their revenues, protect margins or reduce their operating costs and working capital requirements? Then you should look at their customer proposition, how do you make that more attractive, how do you help increase customer purchase rates or reduce customer churn? From an operational perspective, how do you help them run their business more successfully? Finally, and this may be your biggest trump card, what is their risk exposure should they switch your business to a competitor? As they say in the Dr. Pepper TV advert ‘what’s the worse that can happen?’

ii) You then need to understand who are the key stakeholders for the sourcing project within your client. Who initiated the sourcing review and who stands to gain from maximising cost savings? Who are your key allies, the people who depend on your products and services to be successful in their jobs? And who is championing your competitors and what do they have to gain. Once you have mapped out the key stakeholders, their influence and motivations you then need to develop your strategic persuasion plan to defend and promote your position.
iii) Organisations are not machines, they are filled and run by real live people. And so what? You need to track down the individuals who benefit most from your products and services and/ or have most to lose if you lose your contract. In many cases they may be left out of the loop on the sourcing/ procurement engagement. You need to reach out to them, educate them on your value proposition and motivate them to come to your aid in your difficult hour. So who are those individuals in your key clients? And how can you help them organise a coalition to champion your cause within your client’s organisation?
iv) You still may have the opportunity to influence the process to put you in an advantageous position. Get hold of competitive intelligence on competitor pricing, value propositions and how well they actually perform. You need to get an understanding of where they are strong and weak. To win the day, you need to have the key evaluation criteria focused on areas where you are strong and your competitors are weak(er). If you fail to get the evaluation criteria most heavily weighted to your strongest positions then the decision becomes all about price or perhaps more accurately who is going to win the contract by being willing to accept the largest losses (a not unusual position to end up in for large-value outsourcing contracts in my experience).
v) You need to start to get your negotiating terms and positions worked out early so you are prepared for the tough negotiations to come. Ultimately you need to have engaged the leadership of your organisation to clarify your negotiating terms, pricing options and the trade-offs of the various negotiating issues. It’s time now to reach out to your colleagues in Finance (who will need to agree the numbers) and Operational functions (who will have to deliver the agreed outcome) so that they can contribute towards putting together the winning proposition.What straightforward thing should you do right now?
I would form a ‘War Cabinet’ right now to start work on defending your most valuable contracts. Your CEO or COO will want to be involved, your CFO should be there as the custodian of profitability within the business working alongside your key sales and operational senior executives charged with negotiating and delivering your strategic high-value contracts. It’s vital that one of you is designated the lead person to organise the defence and it certainly helps to set up a formal ‘war room’ where you can put together in one place all the key information needed to run the defence.
If you are wondering how you can define and structure the roles and responsibilities of the ‘War Cabinet’ seehttp://www.closequarter.co.uk/CloseQuarter_RACI.pdf.Summary
The key items for you to consider in defending your most valuable contracts and the ultimate profitability and survival of your business are:

  • The deepening recession will inevitably lead clients to engage in strategic procurement and sourcing projects to reduce their external spend
  • Typically, strategic procurement projects save between 5-20% of costs (depending on the purchasing category) with an average save of around 13%. The direct impact of this saving will be on your operating margins
  • The weaker your position, the heavier you will need to discount and the greater the risk you face of losing your contracts to a competitor
  • You should start immediately to identify and strengthen your clients’ perceptions of your value proposition, your competitive differentiation and the risk impact of switching from you to a competitor
  • The battle will be won by creating a ‘winning coalition’ to support your business within your client’s organisation. Start rallying and organising that coalition immediately before it’s too late to save the day

Yes, your most profitable contracts are at risk right now. However, the better prepared you are to protect your most valuable contracts then the stronger your position will be to defend the profitability and cash flows of your business.

Best wishes John.