CUSKAS PROFESSIONAL COLLEGE Defining Business Need [L4u2] Core Study Guide Level 4 Diploma in Procurement and SupplyPrinted and distributed by: The Chartered Institute of Procurement & Supply, Easton House, Easton on the Hill, Stamford, Lincolnshire PES 3NZ 7 info@cips.org www. cip5.0°8 t Copyright © CIPS 2018. All rights reserved: * No part ofthis publication may be reproduced, stored in a retrieval system, rented, hired, transmitted in ary Term or by any means, electronic, mechanical, photocopying, recording or otherwise, without permission in tering from the publisher or under licence from the Copyright Licensing Agency Limited. Further detal's of such licences (for reprographic reproduction) may be obtained from the The Copyright Licensing Agency, Sth Foor, Shackleton House, 4 Battlebridge Lane, London, SE! 2HX. Every attempt has been made to ensure the accuracy ofthis study guide; however, no lability can be accepted for any loss incurred in any way whatsoever by any person relying solely on the information contained within it The study guide has been produced solely for the purpose of professional qualification study and should ot be taken as definitive of the legal position. CIPS cannot be held responsible for the content of any website Trentioned in this study guide. Specific advice should always be obtained before undertaking any investment. ISBN: 978-1-86124-289-1 ‘ACIP (Catalogue in Publication) catalogue record for this publication is available from the British Library Allfacts are correct at time of publication. ‘Author: Stephen Carter BS¢ MBA First published in 2019 by CIPS Editorial and project management by Haremi Ltd Typesetting by York Publishing Solutions Pvt. Ltd., INDIA Index by York Publishing Solutions Pvt Ltd, INDIA Every effort has been made to trace all copyright holders, but if any have been inadvertently overlooked, the Publishers will be pleased to make the necessary arrangements at the first opportunity.LUSKAS PROFESSIONAL COLLEGE Contents Your qualification MANAGEMENT 0968 70044 2/0s%0 Kine Guide to qualification content “ ‘About our exams and your study commitments wii How to use this book vi Book features Defining Business Need x Chapter 1 @ Understand how to devise a business case for requirements to be sourced from external suppliers 1 @ _ Analyse how business needs influence procurement decisions 2 + Type of purchase such as straight re-buy, modified re-buy, new purchase 2 + Implications of the business needs on the type of purchase 5 + Procurement's role in developing a business case 10 @ _wentify how costs and prices can be estimated for procurement activities soa + Types of market data that can provide information on costs and prices 22 + Direct and indirect costs 2s + Produting estimated costs and budgets 28 + Approaches to total cost of ownership/whole life-cycle casting 36 © _bnalyse the criteria that can be applied inthe creation ofa business case a) + Examples of criteria typically applied in the production of a business.caseicast3, \ benefits, options, alignment with organisational needs and timescales sé At + Benchmarking requirements @ interpret financial budgets for the control of purchases, + The purpose of financial budgets * Cost entries and timings of cash flows + Performance and contrat of budgets + Dealing with variances to budget Chapter 2 © _Understond market menagement in procurement ond supply @® _pnatyse the aiferent types of markets utilised by procurement and supply « + How to analyse a market Siac a + Specific markets LUSKAS PROFESSIONAL ja * Manufacturing pene ay “ * Construction i % » Retail 01% * Financial dO MAY 2048) Fg x * agriculture wx Eeces ERE, a ores.Contents —————- Compare the competitive forces that influence markets «Bargaining strength of buyers and suppliers + availabilty of substitutes and threat of entry Contrast the breakdown between direct and indirect costs and the types of data that can provide information on cost and price «+ How to collate sources of information to estimate the breakdown of costs between direct and indirect costs for purchased goods and services « How to use information to prepare budgets or to negotiate prices * How to research and use market data to estimate and negotiate current and future prices and costs for purchased goods and services Chapter 3 ° ® ® ® sdentity opportu Understand the use of specifications in procurement and supply Analyse different types of specifications used in procurement and supply and sources of information that can be used to create specifications + Drawings, samples, branded, technical + Conformance specifications + Output or outcome, statement of work based specifications + Standards + The Internet + Suppliers + Directories Identify sections of specifications for through-life contracts + Scope + Definition + Description of requirement + Testing and acceptance + Change control mechanisms and remedies + Social and environmental criteria Identify the risks that can result from inadequate specifications and mitigation approaches * Under- and over-specified need +, How to monitor specification creation by colleagues and other internal stakeholders, s to regulate short- and longer-term specifications * How to implement standardisation + Value analysis + Value engineering * How to provide guidance to internal stakeholders on implementation Glossary Index 88 92 7 98 103 106 115 116 116 118 19 125 125 126 130 130 131 132 133, 134 135 137 140 140 146 150 150 160 1 173 W7 183Your qualification COLLEGE 30 MAY 2019 MANAGEMENT centioves 20040270980 202 KITE CIPS qualifications are regulated internationally to ensure we offer a recognised, professional standard in procurement and supply. CIPS Level 4* Diploma in Procurement and Supply is a vocationally related professional qualification. Formal recognition is included within the regulatory frameworks of an increasing number of countries such as the Uk (England, Wales and Northern Ireland}, UAE (including Dubai) and Africa including Zambia). Further information Con this recognition and the details of corresponding qualifications levels for other international gualifications frameworks are detailed on our website. CIPS members can have the confidence in our regulated qualifications, which reliably indicate the standard of knowledge, skills and understanding that you, as a learner, are required to demonstrate. ‘step up from the Level 3 Advanced Cerca in Procurement and Supply Operations, the Level 4 Diploma in Procurement and Supply i stepping stone to study onthe GPS Level 5 Advanced Diploma in Procurement and Supply ‘Te content has been writen using the CIPS Procurement and Supply Cycle 35s focus, which presents 3 cyclical x0ce55 okey steps faced by thore procuring goods or Services. The Diplama offers the most common enty route tothe profession and should be used by learners to develop a protessonat toolbox which learners can appiyin the practical environment and further develo at Levels Sand 6 ney eet nr tee Inch ay success leaers wl posers transferable workplace Sil deroping thes operational andtacical abies thay ‘tvelor managerial eles nd responsaltes i aed at hose Intheprotessonwhohave procurement and supp city atibeheat ofthe role. Learners wale expected to prowde ‘tice and pudance tole sakeholerson te performance of rgastional procedures ane processes asocated vith procurement and supply and wl spe manage evelopment a improverenis ote rated fenions Traserable ss are bosesuchascommurcation tar work, 2 panning and completing tasks to igh standards al enatle thelesmer to adavalueto the expansion, Procurement and Supply ‘This qualification provides progression tothe CIPS Level 5 Advanced Diplomaixte to Qualification content: Guide to qualification content What will I study? Eight CORE modules make up 60 required credits =o Who is it for? ‘This qulfcatonis the essential toot for anyone Panning acareerin procurement and supply Developed and writen using the Procurement and Supply ce 35s focus. itis tthe same evel a the fist year ofan ‘undergraduate degree course. ts sutablefr those in operational oles those managing oF superising the procurement and supply function whe want to ‘develop ther career and work towards MCPS Chartered Procurement and Supp Professional What will | tearn? ‘Younillarn about making procaement and supply happen within an organisation, an you willbe equipped wth an essential arge ofnonledge and toolsthat you can app immediately n your werglace earn how to pp Practical theoretical ndtechcal knowedge pina Gear Understanding of procurement and supply and Seely the aly to ads complex nor routine probes. (On completion, youwil beable to analyse terpret and a & tsahterdeantniomaton andidessndhovesn A \ ‘iomed onsen: ot leingpespechesond sprcanctnepdenmrormlanaratety ‘eae review the elfectveness and appropriateness of methods, actions and results, Entry requirements + me recurement pt Bre qtelpreessf Tiss the only entry point onto our Diploma eters ten proc qualifications. A minimum of atleastwo levels (or nde ers Internationa equivalent or a CIPS Level 3Advanced —— memepserenatl Certicate qualification isrequied.Akernatvely, youll kowledgefprocarement eed a minimum of twoyears relevant expenenceina a business envrcrment Credit values Togain a quaiicaton you are requtedto complete a total umber a redts.Thisisa way of quantifying the equied umber of study hours. 1 creat equivalent to TOhours of sud. Fach modules gwen acredt wae of6 or 12 crests. Totals requredforcompletionAbout our exams and your study commitments About our exams and your study commitments Objective Response exam format (OR) ‘These questions allow you to select a response from alist of possible answers, Youwil fin these types of exams across all ur qualficatons levels an they _a1e marked by computer and then moderated by CIPS examiners, Constructed Response exam format (CR) “These questions require you to create or tonstruc’aresponse tothe question such as an essay o case study. You wal find this type of examin cur phoma level qualifications and they will be marked by subject expert exarners. Your total qualification time (TQT) ‘The TOT indicates the overall number of guidediearing hous, adltionalsefstudy and assessment time thats required. Guided learning hours (GLH) leis expected that you will undertake 250 GLH. The defniton of guided learning hours is A measure ofthe amount of input time required to achieve the qualification. Thisineludes lectures, tutorials and practical, aswell as supervised study in, for example, leaning centres and workshops. Self-study requirement (SSR) _ ‘Addkional we recommend that you also comtto at least 335 5SR hours. This includes wider reading ofthe subject areas and revision t0 give yourself the best preparation for sucessfully achieving the quaifeatio. Total exam time ‘Allthe modules in IPS qualifications are assessed by an examination.HOw (o use this book << How to use this book Welcome to this study guide for Defining Business Need. It contains all the information needed to prepare you for the assessment in this module ‘This study guide follows the order of the module specification and each chapter ‘elates to one of the learning outcomes below. You can also see the assessment criteria for each learning outcome. By the end of this chapter you will understand how to devise a business case for requirements to be sourced from external suppliers. Learning outcome i ay the end ofthis chapter you wll understand ee es how markets can be managed for the beneft of outcome | procurement snd supply Learning outcome By the end of this chapter you will understand how to use specifications in procurement and supply. villGlossary ‘These are the key terms and their definitions Book features ——— book features ‘Throughout this book there are a number of features to aid your learning and simplify your revision. Take a look at the different features you will find in the book below. Remember ~ This information is important, so you should make a note of it. Check ‘These revision questions give you a chance to check you understand the content in this chapter. ———— Apply These tasks give you a chance to test out your knowledge and understanding Recap This information will summarise sections from previous chapters, These case studies will relate the content you have learned to real-world examples. ey ty Recommended reading ‘These books can give you more understanding on the subject. 0] 2 [i] | Link iPS krowiedge where members wit = | be able to access additional resources to extend your knowledge, plus links to online eLearning content including videos, audio and interactive quizzes to recap and test your knowledge and understanding. End of chapter assessments At the end of each chapter in the book there is a set of exam-style questions to prepare you for your assessment. End of Chapter Assessment @ The National Health Service (NHS) in the UK is an example of an organisation from which sector? a. Public Third b. Private Primary \Defining Business Need [4mz2] ‘Module purpose ‘on completion ofthis module, learners willbe able to devise a business case for requrements to be externally sourced and wil understand the ole of market management and compettive forces as they spec goods and serviesin procurement and supply Module aim(s) ‘Te development ofa business case and the ably to analyse markets arekeyif an organisations to successful source activ from external supplies. Similar, the tion of specications for through fe contacts crucial to overall Business ear achievement Ths module is designed or thse who are expected to analyse, interpret and {evaluate information on the aifferent types of markets utlised by procurement and supply. IRexploes a variety of elements that underpin the development of business cases and specications and considers the options that shouldbe explored when procurement and Supp personne are involved in defining requirementsCHAPTER 1 Understand how to C devise a business case for requirements to be sourced from external suppliers Learning outcome By the end of this chapter you will understand how ~—* to devise a business case for requirements to be sourced from external suppliers. Chapter overview @ Anaiyse now business needs influence procurement decisions You wal understand * Type of purchase such as straight re-buy, modified re-buy, new purchase + Implications of the business needs on the type of purchase * Procurement's role in developing a business case Identify how costs and prices can be estimated for procurement activities You will understand: >ROFESSIONAL COLLEGE * Types of market data that can provide information on costs and prices * Direct and indirect costs * Producing estimated costs and budgets * Approaches to total cost of ownership/whole life-cycle costing LUSKAS PF Analyse the criteria that can be applied in the creation of a business case You will understand . * Examples of criteria typically applied in the production of a business case: costs, benefits, options, alignment with organisational needs and timescales + Benchmarking requirementsCHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers —_ Liability Responsibility for a financial payment Business case Adocument that sets out the justification for undertaking a project on commercial grounds Corporate goals The targets set by an organisation fr company that, will achieve the ‘organisation's mmission or abjectives Straight re-buy The purchase of anitem that was, purchased last time there was a need rather than considering an atternaive Modified re-buy ‘The purchase of aniter that was purchased last time there was a need, butwith changes to the specification or supplier New purchase The purchase of an item forthe first time Interpret financial budgets for the control of purchases You will understand + The purpose of financial budgets + Cost entries and timings of cash flows + Performance and control of budgets + Dealing with variances to budget Introduction Sourcing requirements from external suppliers commits an organisation to a cost and a liability. The cost of these requirements reduces the profitability of an ‘organisation (or consumes part of a budget in a non-commercial organisation), If the requirements are not paid for in cash, then the sourcing decision also. creates a liability in terms of a future payment that has to be made, By sourcing from external suppliers itis assumed that the purchase will help to create value over and above the cost, in a manufacturing organisation, for example, raw materials are sourced from external suppliers and used to make a finished product that is worth more than the cost of those raw materials. ‘The greater the value of these external requirements, the greater the risk to the organisation as the extra value may not be created as expected. Prior to making very large purchases it is best practice to evaluate the casts and benefits of the proposed procurement. The way to do this and abtain the agreement of senior management is to write a business case. The purpose of this first chapter is to provide some guidelines on the content of a business case and how it should best be prepared © Analyse how business needs influence procurement decisions A business case is never written by a procurement team in isolation from the rest of the organisation. Anything that is procured should help further the organisation's corporate goals. This means that what the business needs in order to meet these goals will influence what gets procured, from what markets and how, This section looks at the following, + The three different types of purchase that can be made The implications of business needs on these types of purchase The role that procurement has in developing the business case Types of purchases ‘When making a decision to purchase an item, a buyer is faced with three possible scenarios. The tem to be bought could be a straight F odified re-bu oranewpueian ea straight re-buy, a modified re-buyStraight re-buy asthe term implies, a straight re-buy is the purchase of something that an organisation has bought before and for which there is an existing and agreed specification, The purchase is usually made {rom an existing supplier on an approved supplier list. This type of purchase 1s a routine one in that itis for an item that is used continually in the operation of an organisation. Here are some examples, + MRO (maintenance. repair and operational) items - these are routine tems that are used for the running of an organisation and include services, such as cleaning and spare parts for machinery. + Utilities such as gas, water and electricity. + Raw materials such as steel and bulk chemicals, ‘The purchase is often of relatively low value or low risk to the organisation if there isa disruption in supply. There are usually many alternative suppliers available and the cost of switching is low. sa result, a straight re-buy requires minimal, if any, research into alternative products and alternative suppliers or any negotiation of new prices. These tasks are usually done when re-letting the contract. Straight re-buys are often a call off from an existing contract or framework agreement. Purchasing or procurement cards (often abbreviated to P-Cards) are a way inwhich organisations can make purchases without having to use a formal purchasing process. They are generally used for low-value items. Modified re-buy ‘A modified re-buy is the same as a straight re-buy but with some changes. Here are some examples. + Abuyer sets a cost reduction target for the year and so attempts to get the same item for a lower price from the same supplier. + Abuyer reviews the number of suppliers it has and finds that it has multiple ‘suppliers for the same item - the buyer chooses one supplier and renegotiates, terms to get a volume discount. + Acchange in regulations means that a product has to be modified and this, requires changes to the specification of components that are purchased. Unlike a straight re-buy, the modified re-buy requires more effort from the buyer to find an acceptable solution. It could be said that the buyer has to use a certain level of problem-solving skills to achieve their objective. Modified re-buys are most common for items such as the following. + Components for production + Consulting services using a consultancy that the organisation has used before but with a new brief + Software bought on the basis of a number of users (e.g., expansion or contraction of the business will change the number of users) CHAPTER 1 Understand now to dewse a business case for requirements to be sourced from external suppliers (14) z cE Approved supptier we 1s of aperved svenecnore pees teorenmate techn taneanal orn eerate he ork calloft The purchase of anitem using, a framework ‘agreement that has already been through a procurement process Framework agreement ‘An agreement that sets our the terms and conditions under which a call off can bbe made Volume discount Areduction in the usual price when a minimum quantity is ordered (also called a ‘bulk discount)SNAGTER-1 Understand how to devise a business case for requirements to be sourced from external suppliers — Critical path The sequence of steps in a project plan that together determine the shortest time to complete the project Business requirement The activities that meet the need of, and provice value to, the business (also. called business need) Specification A detailed description of what is eequiced Supply market The marketplace Inwhich suppliers conduct business Key suppliers Externally located suppliers - either people or organisations - who are essential to the successful delivery of a business’ objectives Invitation to tender (ITT) ‘Avwritten invitation for a supplier to submit a bid containing 2 description of the information the buyer requires in order to select the best offer and award a contract New purchase New purchases are made when the organisation identities a completely new requirement, suchas in the folowing examples + Anew product is added to an organisation’ offer, that uses materials or components not sourced before + There are changes in legislation which mean a public sector department has to offer a new service that requires skills and experience not used in other services that are already procured. + Technology changes and new equipment is needed, Procurement skills are most needed in new purchases, which generate the most work for procurement staff, These purchases have many of the characteristics of a project in that they have a definite start and end date, need a range of skills and involve interdependent tasks, some of which are on the critical path, that determine how long the project will take, Tasks in a new purchase include the following + Understanding the business requirement + Writing an effective specification for what is needed + Researching the supply market + Researching key suppliers in that market + Deciding on the key capabilites that suppliers must have + Writing invitation to tender documentation + Managing the tender process + Negotiating + Selecting the supplier Figure 1.1 summarises the three types of purchase with examples. + Utilities (gas, water, electricity) Straight + MRO (maintenance, repair and operating items) re-buy + Raw materials (eg, steel, coal, chemicals) + Services (eg., consulting) + Components and semi-finished products “1c + Capital items New «Finished products Purchase — + Products from resale ~ Figure 1.1 Three types of purchaseImplications of the business needs on the type of purchase Whether an organisation operates in the public or private sector, it has a mission or purpose to achieve. For a private sector organisation this might be to supply a specific group (or gr0ups) of customers with products that meet their everyday needs or improve their lives in some way. By doing so, the organisation aims to maximise its profits and provide a financial return to its shareholders. Public sector organisations, on the other hand, are set up to provide people with services that are not available from the private sector or are better provided by & nonprofit organisation. In either case, the mission of the organisation will determine its business requirements, which in turn will affect what procurement needs to source and how it goes about it. Apply Make a list of ten things you buy - either at work or in your personal life. Against each one write down whether itis a straight re-buy, a modified re-buy or a new purchase. Think of at least three items for each category. 1 ZA ; u oY (| Regulatory bodies Public authonines (or gavernmet agencies that have responsibilty for overseeing and supervising a specified activity Capacity The output of a business Target costs The expected cost of ‘making a praduct or delivering a service —— One way to identify business needs is to use a model with the acronym RAQSCI (pronounced rack-sk). This model takes six themes of needs and ranks them in a specific order, 1. Regulatory. This covers any legal requirements or requirements of regulatory bodies. . Availability. This covers the continuing supply of goods and services when required and is based on factors, such as capacity, financial stability and risk. . Quality. This is the consistency, repeatability and how fit for purpose the procured goods and services are. Service requirements. These are factors associated with the way services are supplied, for example, flexibility, availability or support, such as help desks. Cost. itis only after the other factors have been met that cost should be considered in aspects of both cost and price, e.g. target costs, total cost of ownership, benchmarked prices, continuous improvement. Innovation. Finally, itis necessary to look for innovation, particularly in terms of the means of improving the customers’ experience. Examples include the use of emerging technology, customer of first choice and capability improvement. The order in the RAQSCI model is crucial as it focuses attention on potential trade-offs that may have to be made Total cost of ownership The sum of allof the costs of acquiring, Using, maintaining and disposing of ‘an asset over its expected lifetime Benchmarked prices The price paid fora product or service either inthe past or by other users inorder to set a standard for future reference Continuous improvement ‘The ongoing activities Involved in improving a process, product orCHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers —— —® [az] Criteria Principles or standards used to judge or decide something Performance measures Standards, targets ‘and metrics used to collect and analyse information on the performance of an individual or contract Sourcing strategy A plan for creating ‘an advantage by continually reviewing current needs ‘against purchasing opportunities When defining business requirements, involving a range of stakeholders within the organisation allows procurement professionals to take into account the different stakeholders’ conflicting needs and to agree in advance on any compromises that must be met. ‘Once identified, the business requirements will be used to inform a range of procurement activities, such as the following, + Defining evaluation criteria + Testing the available options to ensure they satisfy the company's overall needs + Developing performance measures + Re-evaluating your sourcing strategy if circumstances change Table 1.1 gives an example of a business requirement identified using the RAQSCI model. tis based on the requirement for the provision of a service in the adult social care market, ‘Must comply with Safeguarding Vulnerable Groups Act 2006 Regulatory requirement Must have the capacity to offer 98% of our ‘Availability requirement | placement needs on demand Must be able to demonstrate financial stability Must have a minimum of two-star CQC rating, Quality requirement ‘Supplier must show evidence that it has processes in place that assure quality standards are achieved consistently Must have a help desk available to enquirers for Service requirement core hours: 09:00 to 17:00, Monday to Friday Unit prices will be at or below published average levels Cost requirement Processes are in place to deliver continuous improvement that achieves agreed deflation levels year after year Processes in place to adopt and adapt new Innovation requirement _| technology available to the sector to improve service standards nie teal Table 1.1 RAQSCI: Provision of care service in the adult social care market Check What are the six themes of the RAQSCI model? Why is the order of the six themes important?CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers There are a number of things to consider when defining business requirements, + Collect information relating to the organisation's desired future state. In order to ensure alignment with organisational needs, the information should be complete and should include the corporate and business unit strategies, the business plan, any technology roadmaps, and all policy statements. + Categorise all potential stakeholders. Face-to-face meetings with individuals (or their representatives) enable procurement to bétter appreciate different stakehold: er needs, The needs of the stakeholders will need to be prioritised, so an under: standing of what actually matters (and why) is essential for correct prioritisation. ‘+ Identify individuals who contribute to the acquisition, manufacture or use of the producuservice. Confirm with them that, to the best of their knowledge, the technology or processes used are unchanged and not likely to change. Otherwise, this will affect the business requirement. + Oncompletion, the analysis should be summarised and shared with all the stakeholders, While stakeholders are likely to have different needs, the procurement team will need to balance these competing needs to identify a Solution tat achieves buyin from the majority or the most important. Requisition ‘The process for gaining an understanding of different business needs has raised by a user or a store to communicate to procurement the need to buy the different implications for each type of purchase. Straight re-buy product or service specified For straight re-buys the business need will already be defined and specifications Purchase order will be in place for these items. Generally suppliers will already be contracted to Acommercal agreed terms and conditions, and the procurement task is a straightforward one document issued by of raising a requisition and placing a purchase order. Testing and challenging the 2 buyer to a seller business need and the products and services that meet them is something that Seous or erces should be done as part of an annual planning cycle but not something thats, Se crcatogether needed every time the item is replaced vith the quantity and Specification needed Itis possible to decide if a purchase is a straight re-buy if one or more of the Pe following apply. aae” planning + Alist of approved suppliers exists and terms and conditions have previously Planning involves 2 been need Pees + The process for ordering is procurement approved and routine aims exploring, ing Modified re-buy sae eater if the item is a modified re-buy then there is value in revisiting the business need, ‘the result where each particularly if itis part of a cost-reduction programme. The best way to do this is to ey rey create a sourcing strategy, using the following steps. aso before the 4. Define the scope of spend for the strategy and the requirements of the user final plan is accepted 2. Assess the current spend (what is Bought where?) oe cmust 3. Assess the supply market (who offers what?) be adhered to during 4. Analyse the total cost (how much does i cost to provide those goods or services?) ms of sevice Or 5. Identify suitable suppliers (who can we buy from?) terms of use) 7. Decide the route to market (a tendering exercise and/or negotiating with suppliers?)CHAPTER 1 Understand how to devise a business case for cequireents to Be SOUrced fom external suppers-——_ & Decide how to implement the new supply arrangements 9. Decide how to track results and benefits 10. Define the trigger events that will restart the sourcing process Trigger events Aset of The scope of the business needs is the most important part of preparing a SGoumetences tat sourcing strategy, Get this wrong and the possibilty of achieving a breakthrough result that achieves a major cost saving and delivers improved service quality and Breakthrough innovation will be greatly reduced The achievement of a The sourcing strategy is a continuous cycle. The scope of a sourcing strategy particulary important determines what can and cannot be considered. The starting point is to define end significant result the category of what the organisation is sourcing, as shown by the following case study. Modified re-buy of cleaning services ‘An organisation decides to go to market for a cleaning contract to service a number of offices. It knows that it will get a price which may, oF may not, be better than the one itis currently paying. To gain leverage in the marketplace, the organisation decides to add other related services to the scope, such as gardening, security and maintenance, which increase the value of the contract. Although this runs the risk of potentially reducing the number of capable suppliers, it decides to go even further and outsource the whole of its property ‘management, as well as sell and lease back part of its property portfolio. This dramatically increases the value of the contract and will potentially achieve even greater cost savings, but itis at the expense of increasing the complexity of the procurement and the range and number of stakeholders who need to be involved, thus adding significant time to arrive at a solution that is acceptable to everyone. This illustrates that an inital definition of a category "such as cleaning services can be changed to identify additional items that can result in a larger saving but with greater risks. This is why itis important that everyone involved is agreed on the category definition to take forward. Questions to ask in order to define the scope of the strategy include the following. * Are there any geographical boundaries that need to be considered? This may be the result of supply market capabilities (for example, the technology needed is not available in certain parts of the world) or because of the sustainable Procurement strategy (for example, not to buy from areas that have a reputation for employing child labour). * What time period should the strategy cover? For example, i the supplier will Reed to make an investment in equipment in order to fulfl the contract, the time period will need to be long enough for them to recover that investment Cost and still achieve the organisation’ target price.+ CHAPTER 1 Under: Understand how to devise a business case for requirements t0 be sourced from external suppliers a ive agreement with other organisations and the organisation is ati of no more than one or two sentences. Here are some examples. ‘Ths alongterm + [maintenance that includes all laptops, printers and multi-functional devices. ma ‘organisation which sets + All grades of boron, carbon and high-strength steels for manufacturing plants ‘out how each party in Europe. Formaton cost ss dnd rest by working ply topetneron a product Think of something you buy regularly, either at work or in your | serve personal life. Make a list of questions you need to answer in order to define the scope of this purchase. \ Now ete dom your sswestotese estore yoo — | AY cannot answer any ask your colleagues or friends and family ‘Once you have answered all of the questions use the answers to construct a short statement of the scope. By considering the capability of the supplier that is being sourced, as well as the product or service specification, itis possible to generate options that substantially Capability increase the value of the modified re-buy. The result is more options for creating a The ability of 8 breakthrough in the cost-reduction plans. supplier tomeet an organisation's ‘Typical capabilities include the following. specific business requires as + Specialist skills =< + World-class processes ToOsKAS + Qualifications from regulatory bodies (e.g. Iso) + Leading-edge software PROFESSIONAL COLLEGE + Specific capital equipment + Unique or dominant access to rare resources (including human skills) Remember When creating your sourcing strategy, remember the following, + Formulate a plan for engaging with all the relevant ‘stakeholders. This includes potential suppliers, who may be able to provide insights into what can realistically be achieved «Be creative when defining the scope of the procurement. Do not simply assume that the products or services included in the previous procurement are what should be sourced this time, «Consider whether a broader range of related products ‘and services can be included to increase your spend and therefore your leverage. + When you have defined the scope of your strategy, present it to your stakeholders in a clear and concise statement of ‘one or two sentencesSHAPTER 1 Understand how to devise a business case for requirements to be sOUrced from external suppliers New purchase ‘The new purchase situation is one that will usually involve many people from different departments. This is because, by definition, the product or service has not been used before and so there are risks involved to the organisation, Examples of risks are as follows. + Marketing needs to agree that the attributes of the product or service are those that are needed to support the required levels of quality, service and cost of the end product sold to customers. ‘+ Engineering needs to ensure that the item meets all of the technical requirements, + Manufacturing needs to be assured that the item is capable of being used in existing manufacturing processes using existing equipment, * Finance needs to ensure that the cost of the item enables the price of the end Product to be maintained, Cheek Why is the capability of a supplier important to a buyer? List three examples of important supplier capabilities. New purchase situations are characterised by the following, + The need is for a new product or service not used before ‘+ There is no existing experience of buying this item ‘+ Alot of information is needed before the purchase can be made + Areview has already been carried out to identify different ways of meeting the eed other than by a new procurement ‘+ There may be a requirement for follow-on straight re-buy orders once the intial purchase has been made Procurement's role in developing a business case Put simply, a business case is a justification for undertaking an action. It captures the benefits of the proposed action, any risks involved and how they can be mitigated, timescales for completing the project and the roles and responsibilities involved (i.e. who will do what), Above all, a business case should explain why something needs to be done and Mot just what needs to be done. Its purpose is to seek approval and possibly finance for the recommended plan of action. 'n procurement, a business case is prepared for a number of reasons, such as the following. * Acontract is coming to an end and the product or service needs to be procured again Cost reductions need to be made and this requires changes to the way the organisation operates * An alternative product or service has been found that potentially delivers @ number of benefits 107 CHAPTER T Understand how to devise a business case for requirements to be sourced from external suppliers Inmany ways @ procurement sourcing strategy (or a category management plan) isa form of business case. severe 'gory management plan) = r identifying the opportunity or problem ‘The first step in preparing a business plan is to be clear as to the opportunity the business case will exploit or the problem the business case will solve. managers are faced with solving problems from time to time, but itis often best totreat a problem as an opportunity to do something differently and so create value. For example, a business that supplies the public sector can be faced with shrinking government budgets and therefore fewer sales, Treated as a problem, a response by suppliers could be to reduce their own costs which would allow them to reduce their prices (solving a problem). An alternative could be to outsource the public sector part of the business to a third party and focus the organisation's own resources on developing new markets (taking an opportunity. Alternatively, a problem may relate to a situation in which there is uncertainty cor difficulty that prevents an individual or organisation from achieving a goal or completing an activity. Problems can be divided into two groups. + Closed problems. These appear when something happens that should not have happened + Open-ended problems. These are where something is stopping the achievement of an objective or blocking progress Remember Problem solving is about finding ways to correct situations v3 (closed problems) or unblock the blockages (open-ended problems). By thinking about problems in these two groups (closed problems and open-ended problems), itis possible to start to see what sort of problems might arise in procurement work. For example, closed problems might include the following. + The price of a key raw material suddenly increases and makes a product less profitable ‘The level of buying off-contract increases quickly and incurs unnecessary cost. Buying off- for the organ contract the organisation ‘The purchase of ‘An employee is under-performing and not achieving the expected results an item without a Contract when a There is an unusually high level of purchase invoice errors Contract for that item already exists Open-ended problems that procurement might face include the following, Agreement from senior management is required for an additional budget to hire people into the new organisation structure * There is an emerging monopoly in a key market and competition needs to be stimulated 10% cost reduction is needed across all purchases to meet new corporate objectives 4n individual wants to start a category management programme but the Organisation will not co-operate "CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers n When faced with a problem that needs to be solved, often people make the mistake of trying to jump straight to a solution (see figure 1.2). Problem ear Solution Figure 1.2 Jumping from a problem to a solution More often than not this does not work. This is because the problem that has been identified might not be the real problem and so the solution arrived at is, inappropriate. Furthermore, there may well be a better solution available that has not been considered, [A much more effective way of approaching the problem is shown in figure 1.3, Problem Solution £ if Problem definition Tex b 1 ee Hypotheses collection bypothe : | Analysis | Mp | insight Figure 1.3 Moving from the problem to the solution Another way of identifying a problem is to use ’S Whys’ analysis. This starts with the problem and then asks five times: ‘Why is this happening” (in practice it might, ot be possible to generate five successive ‘whys. or alternatively there might be more than five - the important thing is to ask why? enough times to be satisfied that the final answer is the root cause of the problem.) This defines the real problem, ‘Once itis clear what the real problem is decisions can be made regarding what data needs to be collected. Whenever possible, problems and solutions should be evidence based, From the insights gained from this data analysis, ideas can be developed (or hypotheses) for how to solve the problem before choosing the best one. The following case study shows the 'S Whys' analysis in action, Cancettevion of operations in a hospital Ahospital needs to understand why its failing to meet targets, cancelling too many operations and sending patients home on the day of their operation. It undertakes the’S Whys' analysis to identify the problem and then find a solution: <€ fpms ase)“a ‘HAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers, Describe the problem: Too many patient operations are cancelled Apply thes Whys’ Why is this happening? Why 1: Because no sterlised equipments available Why 2: Because there are insulficent sets of equipment Why 3: Because the sterilsing process takes too long Why 4: Because the sterlisers are not used properly Why 5: Because operatives have not all een trained An easy solution would have been simply to buy more sets of equipment, having identified that not enough are available ater the frst why?, but this would have been very costly, A cheaper and more effective solution is identified by the final why?, which i to train or e-train those operating the sterilising equipment so that more sets are made available sooner. Solving the problem Once the problem has been identified, the following eight-step process is a useful model for solving problems in procurement. Step 1: What is going on? Closed problems are often identified using performance monitoring systems This iswhere a target is set and the actual results are measured. Any variance between the target and the actual results indicates that there is a problem. For example, if a target is set that 2% of goods received from suppliers will be rejected for Quality each week, but in one week the level is 5% itis clear that there ‘sa problem, However, nothing is yet known about the cause of the problem. The following case study shows an example of a technique that can be used for defining closed problems. itis called the Kepner-Tregoe approach Trouble on boar Apo 13 Doctors epne and reve detopedanapreach or ._( QE) pulling 2 detailed dfintion of a problem which was used to great effect by NASA to hep find the problem on board Apollo 13. ‘The Kepner-Tregoe approach consists of answering, a series of questions about the situation, such as the following, + What is the problem? + What is not the problem? + What is distinctive about it? + Where is the problem? + Where isn't the problem? Bsourced from external suppliers—__ CHAPTER 1 Understand how to devise @ business case for requirements {0 De SOurce suppliers ——_ + Who/what does the problem involve? + Who/what doesn't the problem involve? + When did or when does the problem occur? + When didnt or when does it not it occur? Here is how it was used with Apollo 13. In April 1970, Apollo 13 was on its way to the moon. ‘When 205,000 miles from earth, John L. Swigert Jr reported that electrical voltage on the second of two power-generating systems had fallen off and a warning light had appeared. Apollo 13 was rapidly losing power and could shortly stop working altogether. (On the ground at Houston, NASA engineers put a form of problem analysis questioning to work immediately. ‘They began to build a specification of the problem from the information that came in answer to their questions and from data displayed on their monitoring equipment. There was no time for NASA Houston to go through a complete listing of all the distinctions and changes they might observe. instead, they asked, “What traumatic change could cause the sudden, total failure in electrical generation” Cutting off the flow of oxygen to the fuel cells would have that effect. A number of fis’ and ‘could be but is not’ questions were asked to get further data and a series of system checks was undertaken to verify cause. The root of the problem was identified: the umber two tank had burst and vented all of its oxygen, plus a large portion of the gas from the number one tank, through a damaged valve and out into space. NASA tested the cause (that the number two tank had ruptured) and found that this would explain the sudden loss of power. It would also account for the bang reported at the time, a shuddering felt by crew members {and the venting of “something .. out into space’. It accounted for both the ‘is’ data they had amassed and for the is not’information that had come from their monitoring activities. More importantly it explained a sudden, total failure within the system In the NASA incident, the presence of a systematic approach of problem analysis enabled a team of people to work together as a single unit, even though they were separated by nearly a quarter of a million miles. (Source: adopted from Kepner, CH. and Trego. 8.8 (1997) Trouble ‘Aboard Apolo il, The New Rational Manager, Princeton: Princeton Reseorch Pres) For open-ended problems, a simple approach is to start by writing down a Problem statement, starting “How do |... 7" An effective problem statement often “4—— CHAPTER 1 Understand how to dewse a business case for requirements tobe sourced from external suppliers ream el ‘How do | create a breakthrough cost reduction of 20% or more?” In this problem statement, stating that it needs to be ‘breakthrough’ implies that Cost-out approach the solution must be radical and innovative, while the target of 20% identifies that The elimination the solution has to be a big improvement on what is currently being done, just of acostin he repeating the current contract and expecting market competition to achieve the ronuacture of a product or the delivery of a service by means of removing an iter from the specification outcome is Not a solution. For a problem such as this, the solution will most likely be found in a cost-out or cost-down approach. Apply, Cost-down, Think about a current problem you face, either at work or in approach your personal lif. The reduction ofa cost in the With this in mind, ask yourself: ‘Why this is happening” Repeat manufacture of this question four or five times until you have arrived at what a product or the you think the real problem is. delivery ofa service by means of changing 'f possible, collect some data to confirm the problem. What {anitem in the does this data tell you about the problem? specication Now think about some possible solutions. Test these solutions with colleagues or friends and family. What do they think? Use this information to choose a solution that is practical Step 2: What do we know? This is the data-gathering step, and might also include verbal comments gained through interviews and surveys. Here are some ways in which data can be gathered, + Interviews. Conduct interviews with a sample of people who have experience of the area being considered. They could be, for example, staff involved in the Production of an item, suppliers of inputs to an activity (such as production) or Customers of the product or service. Questions should be focused and clear and encourage the interviewee to give open-ended responses. Open questions include the words: who’, ‘why’, when’, how’ and where’, * Questionnaires. These should be easy to complete and made up of interesting but non-threatening questions. Questions on similar subjects should be grouped together with the most important questions early in the questionnaire incase the person filling it out does not complete it entirely. Questionnaires can ask either for open-ended answers or provide multiple-choice answers for each question from which the respondent chooses the one they think is correct. * Observations. Looking at how a product or service is used in practice can reveal alot about possible opportunities. For example, a manufacturer of glassware has an issue with glass breaking as it comes out of a covered chute. On examining the inside of the chute itis revealed that a metal part is hanging too low and causing a significant number of pieces to fall over and break * Documents and records. These can be from a variety of sources, such as databases, contracts, financial records or minutes of meetings, ete. 15CHAPTER 1 Understand how to devise a business case for requirements {o be sourced from external suppliers « Step 3: What are the underlying issues? Next, analyse the data collected in the previous step and draw conclusions that help to develop the problem definition. A useful way to do this is with an issues, map. Using sticky notes, write down each issue that Is uncovered on a separate notes. Place all of the notes on a large piece of paper, such as a flipchart, Then connect issues that seem to relate to each other using an arrow. The base of the arrow extends from the source issue and the arrow head points to the Issie st results (or the consequence). Figure 1.4 shows an example. We dont train Less-motivated staff staff Figure 1.4 Building an issues map In other words, the issue ‘we don't train staff’ leads to the issue ‘less-motivated staff By building up a picture of all the issues, it becomes clear that some issues have many arrows starting from them. These tend to be the main causes of problems. ‘There will also be issues that have many arrows pointing at them (see figure 1.5), ‘These are the main symptoms of the problems. Demand not te visibility of driven by business > continuity of work plans | iy Lite workforce | | Few make or buy ‘caeulations | | | performance Who are the Risky to use Too much morioring 00d suppliers? nem suppliers [—* single sourcing site| Totem |” od ree L “Topes® lr — | si | Feeratesarethe vio are the | if ominant factor “key partners? Are we getting value for money? Lack of sis No structured and resource improvement programmes Figure 1.5 Example of a completed issues mop 16~~ CHAPTER 1 Understand now to device a business case for requirements to be sourced from external suppliers step 4: What could we do? t lathis step. Options are generated for addressing the underlying issues and achieving the target set in Step 1 ne simple way to generate options is through a checklist, The following checklist rsknown by the acronym SCAMPER. It 1s easy to remember and can be used as a basis for developing a list of questions. substitute Put to other uses combine Eliminate Adapt Reverse Modify, ach of these key words is used to frame a question for the problem to stimulate the generation of options for solving it. For example, if an organisation is looking for a cost reduction, could it substitute a different item for the one it currently buys? Could it combine the quantity that it buys with that for another item and use the increased volume to negotiate a reduced price? Could it eliminate the item by modifying the specification of the product that uses it? Step 5: What is the best thing to do? Here, the best solution is selected in terms of meeting the breakthrough target and the requirements of all the stakeholders. The following checklist is useful for this . Define the ideal solution. 2, Eliminate those which do not meet any constraints that there may be. 3. Evaluate the remaining solutions against the ideal solution definition. 4. Assess the risks associated with the best solution. 5. Make the decision. Step 6: How do we go about it? ‘This is where a plan is made for implementing the chosen sourcing strategy. The process to be used must be defined and there should be a description of what needs to be delivered by when (also called milestones). Roles and responsibilities will also need to be defined. A good way to define roles and responsibilities is to use a RAC! (pronounced racey) matrix, as shown in table 1.2. The person who will actually perform a task in the plan Responsible ‘Accountable | The person who has overall control of the project and has the power to say yes or no The people who need feedback on progress and may make some input to the work The people who need to know about any decisions made for Consulted Informed theprojet Toble 1.2 RACI matrix The key tasks in the plan are listed and the letters R.A, Cand | are written across the top of the list. This gives 2 table, with each of the cells in the table linking each 7CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers —_| 8 of these letters to each of the major tasks. Then the names of those people who have a role to play in the project are written in each cell Too many people with the same role may mean that roles have not been clearly defined, Too few (or no one at all) may mean that these roles have not been assigned. Step 7: Have we achieved our objectives? Itis now time to implement the plan and test that the target has been achieved and stakeholder requirements met. Here is a six-step process for doing this. Create a team to implement the plan. This can be as simple as having a few colleagues available to monitor and test progress or a temporary team depending on the size of the project Create a project plan with activities, dependencies, outputs and dates. Create a dashboard for tracking and demonstrating progress. This can be 2 simple project plan showing activities that are complete, those that are incomplete and those that are behind schedule, Communicate ongoing activity and results to stakeholders in the project. ‘Adapt the plan to changing circumstances. Not everything goes as expected from start to finish. When the project is completed document the results and share them with stakeholders. Step 8: Can we improve on what we have? This step recognises that things do not remain static for long and so the solution that has just been implemented may need to be amended or reconsidered in the future to allow the organisation to continue to optimise the outcome from the solution. In other words, there need to be trigger events that start the process all over again, solving in procurement. Why is problem solving important? Table 1.3 outlines some dos and dor'ts for problem solving, Make sure there are sufficient solution options to choose from. Rush it. Make sure there is enough time to arrive at a good result Consider all of the options, Approach the process ina random manner. Follow the process steps ‘methodically in sequence, Resist the temptation to miss steps out or rush them because you think you have the answer.Gather enough data and information. | Accept external information at face value, Use the FOG factors: ask if the information is a Fact, an Opinion or 2 Guess. Turn Opinions and Guesses into Facts whenever possible by gathering more data Have clear objectives for the Accept others’ judgments uncritically. problems that you are trying to solve. | Challenge the assumptions they are making in arriving at their judgment, to ensure they are valid Understand and properly apply Be impulsive. Taking short cuts will techniques for evaluating dataand lead to failure. solutions, Be methodical and apply the process consistently. Table 1.3 Dos and Don'ts for problem solving Preparing the business case Now that the problem that needs to be solved (or the opportunity that the organisation would like to take) has been defined and a preferred solution has been selected from a number of options, the next step is to put it all together into the business case, Atypical business case for a procurement new purchase or modified re-buy has the following sections. Executive summary. A clear, persuasive and comprehensive summary of the contents of the business case. Long-term strategy considerations. An analysis of how this business case fits inwith broader purchasing and business objectives. Business requirements. A clear statement of the business need and evidence that cross-functional collaboration has resulted in an agreement on the requirements, Price and cost analysis. Evidence that shows costs have been analysed and benchmarked to show that the target price is reasonable. Market analysis. A clear and perceptive review of the current structure, issues 2nd any likely developments within the market for this item. Supply analysis. Current and potential supplier performance and capability. Technical developments. Analysis of likely trends in technology and 'nnovations that might affect supply. Vulnerability analysis. Identification of areas that might make the organisation vulnerable together with analysis ofthe risks and actions to "inimise them, Sourcing objectives. For both cost and value, detailed in a comprehensive and balanced way, Cross-functional collaboration A group of people with different skills and specialisms Coming together to achieve a common purpose 9‘CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers ——_ + Implementation plan. Roles and responsibilities, tasks and milestones fully detailed. + Competitive advantage. Summary of how this business case will create an advantage for the organisation. ‘The business plan will have to engage and please senior management and directors. It should paint a picture with words, describing how the proposal will affect the things that are important to these individuals. Table 1.4 summarises some elements that appeal to senior management. Returnon _| Senior management are tasked with the financial wellbeing j investment | of their organisations. This has two components: the AlZ ‘amount of profit that the organisation makes and the value of the assets that it uses to make that profit. Profit The amount by which the revenues of a company exceed its The relationship between profit and asset value is the return on investment. Procurement professionals can influence both of these. | costs For example, if they can make a cost saving then this increases | | Asset value the amount of profit and so the return on investment, The value of everything an Time to In many markets new products are the lifeblood of organisation owns market organisations as the first to market gets the largest market Return on share. This is particularly true where product life cycles investment (RON) are short, such as within the automotive and computer profitability that industries. indicates whether a Showing, for example, how the category strategy will result gan or loss has been in suppliers and processes that achieve early supplier generated compared Pe ® ly supp een the alee involvement in product design and development will demonstrate how new product kel product life cycle products can get to market earlier. Thestages a product) customer Acquiring new customers can be a costly business and so Bes tvough satisfaction | keeping existing customers loyal can be key to increasing through to decline sales and reducing costs fang cemoval from ane omen Many organisations have now outsourced key parts of their Productivity operation and these supers have a direct connection with The efficient, and the organisation's customers. etecvenes of efor Demonstrating how a sourcing strategy will result in ortosomesung. | suppliers who have the capability to manage customer measured in terms of relationships on behalf of the organisation will get senior the rate of output per management interested. unitofinput Improving | Productivity means increasing output for the same input, Productivity or getting the same output as before but with less input. If an organisation can achieve this then the result is a better Profit as it can either sell more with the same costs or reduce costs for the same level of sales. The question to askis how the proposal helps people to do their jobs better. A case can then be built around this. 20CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers Risk can never be eliminated but it can be managed or mitigated. Senior management is often unaware of risks that exist within their supply chains. It is important to demonstrate how the proposition can help to identify and then reduce these risks Table 1.4 Framing the business for senior management The business case also needs to be credible. The more facts that can be included the better, although these should not distract from the core of the idea and should appeal to the rational side of the brain rather than the emotional side. Think of how to phrase things so that people can test the idea for themselves using their own experiences, The business case should also tell a story. For thousands of years storytelling has been the mechanism used to pass on learning to the next generation. It can also be useful in business when itis necessary to get a point across, Find similar situations from the past or from other industries and use these to show what the problem was, what solution was used and what the ending was. Then relate this to the current proposition. apply Think of a product or service with which you are familiar. This can be from your work or personal ife. Imagine you are putting forward a business case to senior management for buying this productservice fr the fist ime Write down a lst of things that you think would appeal to ma senior management and therefore be important ‘Against each item in your list write down a few words that say how the product or service helps to deliver these important things, © Identify how costs and prices can be estimated for procurement activities Akey part of a procurement business case is to estimate the costs that will be incurred and the prices an organisation may need to pay. This section looks at the following * The types of data that can provide price and cost information * The diference between direct costs and indirect costs * How to produce estimated costs and budgets * Approaches to total costs of ownership/whole life-cycle costing 2HAPTER 1 Understand how to devise a business case for requirements to be sourced from external upplers-———_ Types of market data that can provide information on costs and prices ‘An understanding of the business requirements will help to target which market to analyse, the kind of information that needs to be collected and collection from what source. For example, in a call centre a business need may be identified about levels of responsiveness to calls. In this situation, the centre might want to consider how it can collect benchmarking information on the average time taken to answer a new call To start, itis necessary to find out whether any research has already been done, This could involve checking with colleagues inside and outside of the procurement department. Its possible that existing data may simply be refreshed rather than collecting data from scratch, There are two ways to collect further information: desk research and field research. Desk research Desk research (also known as secondary research) involves gathering information already available from published sources. This might include market reports, official statistics and trade publications. Some of this information is free, but some will have to be paid for. Market reports and other information can be obtained from a wide range of sources. ‘The local business reference library is a good starting point. Trade associations will have information about specific market sectors and about any relevant trade publications. Official statistics on the economy, population and social trends are shown on. the UK Statistics Authority website, Reports in business magazines and the business pages of national newspapers can be informative, Local authorities and Chambers of Commerce can provide local information. ‘The Internet contains a wealth of business data. Search engines, such as Google and Ask can aid searching, while directories such as Yahoo! make it easy to look for information by sector. Commercial publishers of market reports include KeyNote, Euromonitor, Mintel, Datamonitor, The Economist Intelligence Unit and Market & Business Development. Reports can often be purchased from the publisher's website. The business will have its own data. Analysing sales records or levels of enquiries can provide useful insights. (Source: A Brief Guide to Starting a Home Based Business, p.42. Copyright © lan Nicholson 2010)Here are Some possible questions to ask when monitoring supply market trends tsdlomand for the pradint or rowan or Shrinking? Isnere an foxtncomnng, legislation hat Tah tfoce themarkee emeral ein ahd macket wen? competitors in the ‘supa market changing - what are ‘her plans? How might customer fequirements and uring benaviour charigein the ‘tue? ‘what new products are inthe supplie’s pipeline - could they make the one That is being bought cok outdated? Figure 1.6 Questions to ask when monitoring supply market trends Remember The Internet has made available a large range of information on all kinds of markets. However, be very careful about how you use this information as not all of itis reliable. | Field research You may need data that is more detailed or specific than the secondary data 2vallable from your organisation and from published third-party sources. Field Fesearch is the collection of original or raw data (known as primary data), which Can be quantitative or qualitative. * Quantitative data is statistical. It provides numerical information, such as the Size of the market for a particular product, how many competing businesses Supply itor the prices they charge. Qualitative data tells you about people's thoughts and feelings. Examples might include a customer's attitude towards a brand, or what motwates them to ‘make purchasing decisions. CHAPTER 1 Understand how to devise a business case for requirements to be sourced from eternal supoliersCHAPTER 1 Understand how to devise a business case for requirements fo be sourced from external Suppliers ——_ Request for information (RF!) Adocument used to gather information ‘bout suppliers and ‘heir capabiities prior toa formal procurement process Request for quotation (RFQ) Aninwitation to suppliers to bid on specie products or Request for proposal (RFP) ‘Adocument used to canvass potential solutions from suppliers when te specication i stil unclear Use best practice principles to ensure you gather useful and unbiased data when conducting field research, + Choose a suitable sample of people to talk to. Choosing a small number of people could bias your results by preventing you from gaining a full breadth of insights, or could compromise the depth of your findings. Choosing people who are not knowledgeable enough about the topic could make your data unreliable + Choose the best questioning style. Decide when to ask closed 'yes' or no’ ‘questions, and when to use open-ended questions such as ‘why’ or ‘how’, + Avoid leading questions. It can be tempting to phrase questions so that they {guide people to give the answer you want to hear. Make sure your questions do ‘not suggest to respondents what you think the ‘correct’ answer is. * Consider how reliable your results are. Take into account any biases the people you speak to may have, especially if they could have an interest in providing misleading feedback. For example, a supplier may say that a lowered price for a product is unrealistic, Analyse the results fairly. Do not allow the opinions you already hold to influence how you interpret the data. Never ignore results because you disagree with them, however tempting it may be. Remember Remember that talking to customers and monitoring their buying habits and how they behave is one of the best methods Request for information (RFI) Suppliers and potential suppliers can be a good source of information to use in assessing costs and prices. One way to get this information is by using a request for information (RFI). This is a document used in the early stages of buying a new product or service. At this stage requirements have not yet been clearly defined ‘and so the RFI is a way of testing the supply market to see what is available in terms of supplier capability ‘An RFI does not imply that any procurement will subsequently be made or a contract awarded. tis often used as the initial step before the request for quotation (RFQ) or request for proposal (RFP). Usually itis used to create a potential shortlist of suppliers for the next stage. Here are useful points to consider at the RFI stage. Questions should be framed in such a way that the suppliers are invited to challenge what they are being asked for - the chances are that they will be able to make improvements to the proposed solution that the organisation has provided, Remember that the purpose of the RFI is to gather information, so the document should be brief -if itis too long then suppliers are not going to give it much attention, ‘An RF is not a promise of any work, but it needs to be worded in such a way that it gets suppliers interested - they should put some effort into thel answers So thatthe organisation gets a quality result not just a repetition of something previously submitted, Questions should focus on the suppliers understanding and interpretation of '¢ organisation's problem and not on the supplier's e iteogmsators protien the supplier's capabilities this wil—+ CHAPTER 1 Understan. lerstand how to devise a business case for requirements to be sourced from external suppliers + Suppliers should be encouraged to ask questions - this not only helps them toclarify the organisations real needs but may also give the organisation an insight into how the suppliers think and operate Direct and indirect costs animportant concept when attempting to estimate costs and prices is that of cost defintion. There are a number of aspects to this. Let's start with direct costs and Direct casts indirect costs. Costs that are directly associated with the imagine that somebody is starting a floristry business, There are a number of production of @ good things they will need to buy or pay for to get started or service + Premises Indirect costs ‘The general + Vases for the flowers running costs of the “organisation - these + Marketing print (e.g,, brochures, flyers, window posters) costs cannot easily + Anonline pi be atibuted to Ano Presence specific products or + Acash register services (also known asoverheads) + Ameans of taking credit card payments + Telephone equipment + Equipment, such as pruning shears + Heating + Lighting + Business rates + Staff costs + Flowers + Ribbons * Paper to wrap the flowers in ‘They also will need to consider the products they are selling: items such as cut flowers, bouquets, wreaths and maybe even potted plants. ‘The costs that are directly related to producing and selling these products are direct costs, For the floristry business these include the flowers, ribbons and paper to wrap the flowers, and the costs of any staff directly involved in preparing and seling the product. ‘Any costs that are needed to run the business but that are not direct costs are indirect costs (also known as overhead costs). For the floristry business these include building costs, equipment and business rates. A sophisticated way to look at the make-up of an organisation is that of the value Value chain chain published by Professor Michael Porter of Harvard Business School in 1985." Tre set of acts | Figure 1.7 shows a summary of the value chain. trata value tothe ‘The primary activities in the value chain model are as follows. Sat an * Inbound logistics, interactions with suppliers and the activities of receiving, bbe sold ata profit storing and distributing supplies internally. Operations, all the activities which turn inputs into goods and services (the outputs) which can be sold to customers. ‘Outbound logistics. Activities that receive products from operations, store them and deliver them to customers. 3(CHAPTER 1 Understand how to devise a business case for requirements to be source from external suppliers -———_ + Sales and marketing. Activities that find and keep customers, make them aware of the products and services on offer and determine prices, + Service. Activities that maintain products after sates and achieve customer Secondary activities interact with these primary activities and one of these secondary activities is procurement {| Firm infrastructure Human Resource Management Support o etities “Technology Development procrerent 1020 openers Outound MUHNE Aner sais Logistics OPENS Logistics 2A Service Primary Activites: | Figure 1.7 The value chain Source: Porter, M. E. (2004), Competitive Advantage - Creating and Sustaining Superior Performance. NY: Free Press) - Remember Primary activities are generally direct costs and secondary activities are indirect costs. Fixed costs. Business costs that remain the same irrespective of the Fixed costs do not vary with the level of output of an organisation (figure 1.8). volume of activity of a ‘i For example, in a manufacturing plant the machinery used has a cost associated yusiness with it and this cost does not vary if the number of products made increases. or decreases. ‘Afiother method of classifying costs is to consider whether they are fixed costs or variable costs. Variable costs Acost that varies with the level of output of {an organisation Cost Fixed cost ‘Output of the organisation Figure 1.8 Fixed costs do not change with output Variable costs on the other hand do vary with changes in the number of products made (figure 1.9). The more that are made, the higher the cost; and the fewer~~ CHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers products made, the lower the cost. If no products are made then the variable cost is zero. 12 Vanable cost so cos a 4 ‘Output of he organisation gure 1.9 Variable costs change with output ‘The total cost for the manufacturing plant is simply these two graphs added together, as shown in figure 1.10, feo Ova ofthe orion Figure 1.10 Total cost of output Both direct and indirect costs can be fixed or variable. Table 1.5 summarises this, and gives examples of each combination. ect cost indirect cost r = Fixed cost Supervisor of a production line [Variable cost Raw materials Table 1.5 Both direct and indirect costs can be fixed or variable Costs do not always fall neatly into these categories. For example, in a service organisation staff who provide the service could be categorised as a variable cost asthe more people who are needed the more business is added. However, if there was 9 sudden drop in business, would the organisation fire some staff and rehire when business picks up? Probably notift anticipated that the drop was temporary and it did not want to get 2 reputation for hiring and fring. Instead itmay choose to take a temporary reduction in profits and keep its reputation. Inthese circumstances, the variable cost of staff has become a fixed cost. Human resource fulhtime staff costs, General marketing campaign costs Semi-variable costs Another type of cost is semivariable costs. As discussed, fixed costs do not vary with the level of output of an organisation, but there isa correlation between output and variable costs. Semi-variable costs are those costs that show characteristics of both types: Semi-variable costs Acost that is made up of both a fixed costand a variable costCHAPTER 1 Understand how to devise a business case for requirements to be sourced from external suppliers — Break-even point The level of output of a business at which revenue equals total costs For example, when an organisation is frst formed it may not be large enough to justify 9 felttime accountant as a permanent employee. However, as the business grows there wil come a point when one is essential, This means that a certain level of output has triggered the cost of an accountant which is then a fixed cost This will continue unl the organisation grows to the point where it needs more accountancy staff, | The same consideration of fixed, semi-variable and variable, and direct and indirect costs applies to an organisation that delivers a service rather than a product, opty Think about McDonala's restaurants. What do you think are their fixed and variable costs and direct and indirect costs? Copy table 1.5 and write your answers in the appropriate box. Producing estimated costs and budgets Now that the difference between direct and indirect costs and between fixed and variable costs is understood, the question is how to use this information. There are three main ways, + Break-even analysis + Purchase cost analysis + Purchase price analysis Break-even analysis The previous section looked at the difference between fixed and variable costs and how these combine to give the total cost. The sales revenue line can now be plotted on the same graph. The sales revenue line is the value of different volumes of product sold at the average price. Figure 1.11 shows this. In the figure, there is a point at which the sales line and the total cost line cross over. At this point, sales revenue value equals total cost value. The output of the organisation at this point is called the break-even point, Sales revenue Total cost cost Breakeven point (Output ofthe organisation Figure 1.11 Break-even point ‘The break-even point can also be calculated as follows.* CHAPTER 1 Uniostanl nna 0 devine « business case for requirements to be sourced from external suppliers yed cussts Fenngin the Same no matter how many units of a product are z produived. However, bott sales valine and variable costs change wath the amber 12 of units. TE ust one UNiEs produced, the profits calculated as the sales revenue b inunus he variable cost sales revenue = Rand variable cost » V. This means that for every unit produced a protit of R= Vis made. Hiss often called the marginal profit he fixed cost = F. This means that the number of units that need to be produced isthe fixed cost divided by the marginal profit, This shall be called Q. nother words, when Q units have been produced, the marginal profit is, Qs{R- VIAL break even, this value is also the value of fixed cost F. This means that F = Qs (RV) Divide each side of the equation by (R - V) to get FAR -V)=Q. the marginal profit, ‘wash ‘n’ Go'is a cleaning company. It has a standard price of $10 per item. You estimate that the variable costs are $3.50 per item, and its accounts show ithas a fixed anaual cost of $54,000, How many items does Wash ‘n’ Go have to clean every | day before it stars making a Prom? The importance of the break-even point in procurement that understanding thevolue for a key supplier can be extremely useful in negotiations For example, suppose research and analysis has shown that 2 supplier is currently operating is looking for a price for an above its break-even point and the organisation i deational selume of work, The organisation Can take a negotiating position in the knowledge that the supplies fxed costs have already been met by exstng busmiee art adaitonal business wll oni increase the supplier cost bythe Fe a aecmable cost. The organisation isin a position to argue tha the Pre tte ane variable cost plus a contribution tothe supplies profits, and the al dling pace, Ths is a saving fr the organisation and adtonal profit for the supplier - 2 win-win’‘CHAPTER 1 Understand how to devse@ business case fr requirements 0 Be sourced fFOM exTEFNAL PHS —__ arges the fll price for adsitional work over and above ns per profits ‘Another way in which knowledge of a suppliers breakeven point can help is tha Super-profits i the capplier ngs nat yet reached it an organisation might be willing (0 accep Excess of average a higher price if itis short-term and helps the supplier to break even soc perenne ‘Terns could be added to the agreement stating that the organisation then gers prefs a discount that reduces its costs toa level that more than compensates for the short-term increase. In fact, ifa supplier ch break-even point then it will make su has too little business and needs to keep the workforce busy? if the latter, is this sustainable or does it create a supply risk for you? Check What is a break-even point? What role do fixed and variable costs play in this? Re-read the previous section to check your understanding is correct. Purchase cost Purchase cost analysis (PCA) is a tool that is used to analyse the costs of things analysis (PCA) bought so that strategies can be developed for reducing costs and at the same ‘The analysis of improvi or hips renee time improving supplier relationships individual materi, components and GG simple fact: when the goal is boosting profits obs purchased tem by dramatically lowering costs, a business should Took frst to what it buys.” my PCA helps to answer key questions that ultimately determine the cost of what is bought. + Which costs are both necessary and legitimate in manufacturing this product lr delivering this service? + Are the values for these necessary cost items reasonable? ‘+ isthe overhead allocation to this item potentially subsidising another item which the supplier sells? ‘+ Isthe basis for allocating overheads reasonable? f not, can the organisation challenge the allocation method so that itis more to its benefit? Has the supplier included allowances for contingencies? Does the organisation agree that these allowances are for legitimate reasons? Are the resulting profits reasonable but not excessive and sufficient to keep the supplier motivated and interested in the organisation's account?* CHAPTER 1 Understand how to devise a business case for requirements t0 be sourced from external suppliers, asked of procurement professionals: is the price paid for goods and services the best t could be? It is impossible to answer this _Question without some kind of benchmark analysis. By carrying out PCA you can answer a key question that is often \ ty oa a On the other hand, it would not make sense (and would be highly impractical) couse the tools outlined here for every single purchase item. tis necessary to pronitise, One way to do this is to use the segmentation model shown in table 1.6 ry ~| Leverage Strategic 2 gl g [ters purenased nine items important to distinctive & $) S| qvanciies that are made for stock | competency oF important for the gas Low impact Critical projects Zz | i Low unit cost items Critical projects or long-term capital investments ‘Arms-length Strategic alliance ‘Type of supplier relationship needed Toble 1.6 Segmentation model for PCA (Source: Liso M Ellram, A Structured Methad for Applying Purchasing Cost Management Taals, International journal of Purchasing and Materials Management (Winter 1996) onlinelibrary.wiley.com/doi/abs/10,1111/).1745: 493%.1996 1600215.x) Using this segmentation approach, the quadrant called ow impact'is where low-value products and services bought sit. For these, price analysis (considered in the next section) makes more sense than cost analysis For the other three quadrants there are a number of techniques that can be used. Table 1.7 gives a summary of the more common ones. T Leverage focus = cost analysis Strategic focus = continuous improvement + Open-book costing + Target cost analysis Critical projects focus = jlife-cyclecosting | Trow impact focus = analysis + compenitive bids + Comparison price lists/atalogues |» Total cost of ownership analysis & |+ cost estimating * competitive §) & |: votus anayss assessment/teardown’ 2| § |+ supplier cost breakdowns |, Toeot cost of ownership 5 + ‘Should cost’ analysis ’ a ¢ modellin anclysis 2 * Tocal cost modelling + Total cost modelling of the = supply chain. 3 £ 2 2 One-off + Market comparisons + Life-cycle costing Comparison to past prices [+ Total cost analysis of the supply + Price indexes chain + Comparison to similar purchases ~ | ‘Arms-length Strotegic Alliance Type of supplier relationship needed =a Table 1.7 PCA techniques (Source: Lisa M Ellram, A Structured Method for Applying Purchasing Cost Management Tools; International journal of Purchasing and Moterigis Monogement (wieter 1996) ontinelibrary.wiley Com/doi/abs/10,11 119.1745. 493x 1996,t600215.%) 2 eI Cost estimating The process for arriving at the ‘approximate cost of a product or service value analysis The system: analysis and challenge fof the component parts of a product or service to ensure that the costs fair Supplier cost breakdowns The supplier provides a breakdown of its costs and profit Should cost analysis technique used by procurement for determining What a purchased product ar service should cost based fon the materials, components, processes and overheads of the supplier Total cost modelling A process using algorithms designed toarrve atthe provable cost of a product or service Open-book costing The buyer and supplier agree which costs ‘are elgibie and the ‘supplier agrees to allow the buyer access, toitsfinances to scrutinise these costs Target cost analysis Analysis of market price, ‘volume and profit, from which 3 target producton cost Is derived ENlelel Competitive assessment/ teardown’ The act of disassembling a competitor's or supplier's product into its component parts so thatits costs can be estimated Total cost of ownership analysis Astructured approach to calculating the full costs associated with buying and using an asset or acquisition lover its entire life cycle Competitive bids ‘Suppliers’ submissions inthe process by which an organisation selects, from a number of, competing suppliers to ‘award a contract Market comparisons [An approach for assessing the price of ‘a product ar service by comparing to similar cones available in the market Price indexes Percentage numbers, that show by how ‘much a product or service has changed since a starting point Arm's-length relationship The relationship between two parties each of whom has no obligation to the other Strategic suppliers Those who have an integral role in an organisation's value chain over and above the provision of a product or service Nonprofit organisation Arype of organisation that does not earn profits for its owners but reinvests any revenue back into the organisation 32 [An important aspect of applying cost analysis tools is thinking about the type of | relationship that the organisation has with the supplier. | Arms-length relationships in an arms-length relationship an organisation should apply every tool available toit to build a case for the supplier reducing its prices based on the organisations | analysis of costs. The organisation should not be overly concerned with the supplier's reaction as generally there are more sources of supply available if the supplier is uncooperative. Strategic suppliers Strategic suppliers need to be handled with care so as not to disrupt the relationship. itis necessary to work with the suppliers in carrying out cost analysis having first persuaded them of the need to do it The focus of cost analysis with strategic suppliers is also different. With the other categories of relationship and type of spend, the aim is to get the best possible price based on current costs. With strategic suppliers, the aim should be to work co-operatively with them to find ways of reducing costs to achieve a target cost. For manufacturers, this means first analysing what price they need to pitch their product at in their end marketplace and what level of profit they need to make, Subtracting one from the other will give the target cost for the finished product (see figure 1.12). Itis then possible to work out the target cost for all of the components and materials that are used in making the product. Figure 1.12 Establishing target cost For public sector or nonprofit organisations, the equivalent to the target costs the proportion of revenue that the product or service should equal Target cost setting ‘The starting point for setting target cost is to carry out a PCA in order to understand which components of the product or service are important to the customer, ‘The first thing to do is to make a list of the product or service's components and functions. The list will show what components and functions are needed in order to satisfy the customers’ requirements. Then the relative ranking of the custome's | requirements should be determined. This is not necessarily the same ranking 2 that of the designer of the products and services. The customer ranking canbe | Obtained using a survey of a sample of the organisation's customers. They should also be asked for their relative rankings. One way to collect and analyse all of the data needed is quality function deployment (QFO). This is 8 way of organising the data and relating the Components and functions of the product or service to the customers’ requirements.