Procurement’s role – a behavioral economist’s perspective

March 25, 2013 by

Regions of the cerebral cortex associated with...

Procurement’s role in a modern, giant corporation – discounted by many – is to promote ‘decision efficiency.’ ‘Decision efficiency’ may sound like some piece of business jargon, but it is actually the fundamental reason why procurement is absolutely necessary to an organization. Here’s why:

When people spend money on something, there is some amount of pain associated with that purchase. For some of my tightwad friends, this pain is almost unbearable. Spendthrifts, on the other hand, are particularly good at fooling themselves – i.e. shutting it out of their minds.

I hear the procurement naysayer crowd now…’that’s great for individuals, but what about organizations.’ Ok, maybe you weren’t saying that, but I’ll go ahead and refute it anyway.

People experience the pain of paying to the degree to which they feel directly affected by it. So, while a budget holder may feel mildly connected to the pain of spending some of her budget, the next layer removed will feel even less. By the time we get to the maintenance supervisor that runs out to Home Depot/B&Q on a regular basis, he may actually look forward to some time away from the plant.

Even the budget-holder, however, will be much more in tune with the utility (pleasure/usefulness) derived from an expense or ‘investment’ than the pain. After all, it is one line of expenditure, and the only incentive is to stay within the budget. This phenomenon is called ‘hedonic efficiency.’ I.e. the budget holder wants the benefit and to sweep the expense out of mind as quickly as possible.

What does that mean in practical terms. A). Ownership – i.e. to be able to control the good or service purchased B) Prepayment – i.e. get the money out of there and forget about it.

So, where does procurement come in? We promote decision efficiency. In practical terms this may mean leasing or renting, paying only for what we use (avoiding the prepayment bias), and making opportunity costs explicit. To the extent that we show the utility the business receives against the costs involved, we become an effective conscience for the business. We are there to prevent bias.

Companies – specifically executives – must first be cognizant of the biases that impact them. At that point, they will recognize the need for procurement to be there to counteract those biases.

Procurement has a responsibility here too. We must present the case as clearly and rationally as possible. There is an interdependency present as well. If the business continually shows they do not want to be inconvenienced with the facts, procurement receives the implicit message that their lives will be easier if they just remain quiet.

CEO’s – yep, pointing directly at you – take note.

Michael Dell, what got you here…

March 24, 2013 by
Image representing Michael Dell as depicted in...

Michael Dell Image via CrunchBase

Won’t necessarily get you there. I won’t dare to offer Dell strategic advice without being deeply familiar with your situation.

I will, however, offer you some advice on human bias and the potential effects. You want to take the company private – according to this article in the WSJ. That may not be a bad idea. However, according to the article, the reasons for this move boil down to the fact that Michael Dell wants to continue the current strategy, albeit to a greater extent.

Dell, presumably, does not think investors have the proper long term perspective to realize the benefits of such a strategy. However, the whole idea may be a result of the sunk cost fallacy. People, especially self-starters like Michael Dell, have a hard time accepting that a strategy that they have conceived has been rejected by the market.

There may be a very good reason why investors don’t want to see a corporate double down. For his own good, Dell needs to consider whether he wants to risk his excellent legacy (and part of his fortune) on bucking the market. It’s your call, big guy, and we won’t judge retrospectively.

Choose wisely.

The week in review March 22

March 22, 2013 by
  • The Hub Of All Things is definitely something to keep your eye on. I probably would not do it justice here, so just click the link. There will still be a roach problem festering in storage B when you get back.
  • Procurement really needs to become collaborators and recognize the potential for co-creating value with suppliers if we are to grow our role within the business. Too often, the old-school suspicion of anything new (person, idea etc.) holds us back.
  • Check out this interview with Francesca Gino – author of Sidetracked: Why Our Decisions Get Derailed, and How We Can Stick to the Plan. She has done lots of good primary research on decision-making and where we go wrong. I have personally witnessed sub-optimal decisions made because one party knows that the other party (normally the less intelligent or less informed) will become angry if the decision is not what he/she wants.
  • Cyprus…wow…what can you even really say? Since the trouble with banks has been brewing for years (according to this WSJ article by Charles Forelle, Matina Stevis, and David Enrich), we have to wonder why it had to come to this point. Increasing taxes would make people grumble, but taking a 10-12% chunk all at once is about as psychologically damaging as you can get. The only worse way to handle it is to force people to withdraw cash then grab it out of their hands. I’ve spoken to two Cypriots, and they are not happy. I’m guessing the other 80% of the population isn’t either.
    The Hub's logo

     

Setting KPI’s

March 18, 2013 by

Brief and to the point. Setting KPI’s is difficult, but people tend to make it more difficult than it is. Check out smartcompany.com’s take on setting KPIs. It is mostly in line with my own view, apart from the fact that where they say you can either have many or few, I would strongly emphasize ‘few.’ Especially from the perspective of procurement or managing people.

KPI Park

This area is very near to my heart as I have seen this done badly in a number of ways including:

  • KPI’s that are unrealistic or way out of the control of the party being measured. Nothing will be 100% within anyone’s control, but there needs to be some correlation between the KPI and reality.
  • KPI’s that, if completed, would have very little effect on overall performance. I have been in multiple situations in which I could either perform to the KPI, or I could do the stuff that helps my organization perform better, but not both. Don’t be the organization that makes the employee or supplier make that choice…
  • Don’t be falsely scientific. Formulas that assign 1-10 or high, medium or low should not be part of a mathematical formula. In statistics, high medium or low are called ‘factors’ and are treated differently than qualitative variables. If you think about it logically, ‘medium’ is not necessarily 33% higher than ‘low.’
  • KPI’s not tied to any strategy or even impetus for improvement. If the onus is put on one individual to change the world, but they are not allowed to affect change, then the result is absurdity.

If you are going to tear down, then you must build it back up as well right?

  • Make stretch targets that are achievable – innovative people like to be challenged with reasonably difficult targets…and then get rewarded for doing so. They have to feel, however, that they are possible and that they have the mandate to fundamentally change the way we are currently doing business (how could you get breakthrough results without major change?).
  • Make KPI’s ‘intermediate’. I.e. don’t target suppliers with an increase in your share price (how could they possibly influence the psychological swings of hedge fund investors?), but target them with improvements in productivity in your organization that could be reasonably expected to contribute to a rise in share price.
  • Make them together with the supplier/employee. It is almost a cliche at this point, but people and organizations respond much better when they contribute to the forming of the KPI’s by which they will be judged. They will have insight into what makes for better performance.

There is probably many more on both sides of the line. Give me your KPI success or failure stories in the comments section. If you do, you’ll get a free one-year subscription to TPS planet.

The week in review

March 15, 2013 by

Top model Gisele Bündchen, SPFW

Laziness reigns supreme here on TPS planet. Every Friday, I think “should I delve deeply into a complex topic, or should I go with a notes column?” It pretty much goes without saying which wins.

  • It was good to see the new Pope adopt a stance of humility…if the ‘leader as servant’ role is promoted as a result, well, the Pope will have done business a great service.
  • “Amanpour” (CNN International) actually lives up to the hype. Even when the topic is not of particular interest to me, I still enjoy the show.
  • I love a good tech titan spat, so naturally the increase in Apple vs. Samsung rivalry rhetoric has me excited. I don’t suppose Tim Cook or JK Shin play hockey?
  • In procurement news, Procurement Leaders reports that Diageo is set to decentralize its supply chain. It is a good reminder to procurement, and business people generally, that sometimes greater central control is not always better. Good decision-making involves considering the likelihood that someone else knows more or is in position to perform better. I wonder how well their forecasting works…
  • With all the hype about share price rises and improved corporate profits, let’s not forget about all the value procurement can bring to the table…says the guy who makes his living doing procurement…
  • Advanced negotiation involves mastering whatever context in which you find yourself. The New England Patriots convinced Tom Brady (who could name his price) to take less than what he otherwise could have gotten. How? In short, by framing the debate in terms of the impact to the team around him. Instead of the advantage being with the guy that knew the budget (the salary cap), they convinced Brady to take less for the good of the team. Then they let his friend and trusted teammate – Wes Welker – leave for a relative pittance. My hunch is that Brady would not be inclined to do the same thing all over again. The upside for the Patriots? Tom Brady is 35, and his contract likely takes him through the end of his career. The upside for Brady? He’s still married to Gisele Bündchen.

Procurement governance – not as painful as it sounds

February 28, 2013 by
HONDA CB750. 1969-2003. 750cc FOUR CYLINDER.

HONDA CB750. 1969-2003. 750cc FOUR CYLINDER. (Photo credit: ronsaunders47)

 

I have been thinking lately – yes, yes, the fire department has been notified – about procurement governance. It then follows that neither you nor I will have trouble sleeping tonight.

 

Since I won’t be writing a textbook on the subject, I’ll just pick two items that I think should be considered that, in many cases, are not.

 

  • The Decision-making process – Often, the process for making-decisions is an afterthought. The person or small group that makes decisions assumes that he/she/they accurately represent what is A). Right or B). The will of the group around them. However, ask Loewenstein, Surowiecki, Taleb, or J.S. Armstrong how that generally works out. Two words “Sub” + “Optimal”. Say them together now. Good.
  • Emergent Strategy – I love creating and building systems. It feels like we are being scientific, even though business can only uneasily borrow concepts from our more systematic brothers and sisters.  It feels like we can build a system that, if everyone just performs their role, will work brilliantly. And again, we’ll be….well, right! The problem is that reality has no particular interest in our feelings, and that some of the best strategies emerge from the ground up. Soichiro Honda, can you hear me? Giving people the skills and knowledge to think creatively, and then empowering them to take advantage of opportunities should be part of our approach to governance. My own tendency is to go all out on the rational planning thing, but knowledge and experience tells a different tale.

 

Go forth and do great things.

 

 

Related articles

 

The week in review

February 22, 2013 by
Paul Krugman, Laureate of the Sveriges Riksban...

Paul Krugman, Laureate of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2008 at a press conference at the Royal Swedish Academy of Sciences in Stockholm (Photo credit: Wikipedia)

Outsourcing – the London 2012 debate

February 11, 2013 by

It’s all Twitter’s fault. I was about to start doing real work and then I saw this short article on outsourcing for the London 2012 Olympic games from the CIPS News page.

I have to echo CIPS CEO David Noble’s comments about taking a rational approach to the outsourcing decision rather than making it into a political decision. And that started getting me thinking about outsourcing in general.

I have heard the argument made that outsourcing is generally neither a good or a bad thing…which is right to an extent. The argument goes that when you look at the decision from a cost perspective, whether to outsource or not is simply a decision regarding how to divide up the overheads. However, I like to take a closer look at the situation.

I believe that an organization must decide what is strategically important to them, and what is less so (which is different than ‘not strategic’). I am cringing while writing that last sentence, because many business people are not capable of truly saying ‘this activity is important, but is less strategic when measuring the activity relative to all the other value-generating activities that we perform.’ So consider the grain of salt added.

The reason for the emphasis on what is strategic boils down to who is better at managing an activity. To the extent that an organization can be honest with itself (generally down to the level of introspection of a key leader or group of leaders), that organization will make the right call on in-sourcing or outsourcing. Almost anyone can acquire the technical know-how, but not everyone can manage that activity well or know how to value the activity in the context of the overall value chain (e.g. I may be good at managing something that consumes a lot of my time and whose major problems and obstacles have already been solved/overcome). In this scenario, I’m in danger of re-inventing the wheel.

I could continue rambling, but then I would have to send 8 bosses around to my own desk to tell me how we do things here.

Leave comments and thoughts below. I know you have some.

London 2012 banner at The Monument.

London 2012 banner at The Monument. (Photo credit: Wikipedia)

Leadership from Tom Moore

February 10, 2013 by

I’ve often felt that the military (with all its faults firmly acknowledged) and high level sports (same) have benefited from excellent leadership…much more so than is generally found in the business world.

The quote below from ProFootballTalk.com is excellent evidence of my theory. American football coach, Tom Moore, could have been talking about a procurement department, consultancy, or technology services company.

“Football is a game of people,” Tom Moore said. “There are lots of systems. One of the things you want to make sure you do, and it’s what we are doing, you don’t come in with preconceived ideas. You don’t say, ‘I’m Tom Moore and this is what we’re going to do.’ It doesn’t work that way.”

There are not many in the business world intelligent/wise enough to adapt to the strengths of their people…those that do have a marked advantage over the competition.

Related articles

No PED’s…just cat man energy – the natural way

February 4, 2013 by

Category Management in procurement needs an energy boost. That much is clear.

Energy

Windmills…not much energy, but they sure are pretty! Energy (Photo credit: Open Days – European Week of Cities and Regions)

Now, am I suggesting a call to “Dr.” Anthony Bosch? No, not unless you have a bunch of hats that are too big.

So, if PED’s are unacceptable, what can we do to give our category management projects an energy boost? Well, let’s start with the process to be followed. Step 1…have one! If you make it up on the fly, the risk is that your stakeholder group will spend too much time and energy discussing the process, and not enough time making stuff happen. You – the procurement guy/gal – need to come prepared with your process…hopefully one that, well, works.

So what makes a category management process work? For one, it’s flexible. Not all categories are the same, so it needs to be applicable to a wide range of categories. Think of the process as if it were a platform like Facebook, and the category team is a group of friends. Lots of different groups of friends – with lots of different interests – use Facebook (even you anti-system types…admit it!).

The second one is that it is simple and practical. I have seen processes that go into painstaking detail and cover every objection, but real life happens outside the graphic. Pretty diagrams may impress your friends, but rigorous application of they key points drive value.

Finally, keep up the momentum. The art of the procurement professional is motivating people to make it happen. Go forth and do great things!

www.prometheusprocurement.com

Related articles


%d bloggers like this: