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There are only two problems with inventory – too much or too little.
In the private sector too much means capital is tied up, obsolete stock is growing, operations are threatened and margins are squeezed. Too little means the company runs out of goods to sell or to maintain equipment, customers find another source or binge buying occurs to avoid stock outs. Private sector business management is compromised with poor inventory management. Companies such as Dell recognized how postponement could alleviate inventory investment through JIT; Amazon has taken inventory and service levels to a whole new competitive arena.
In the public sector too much inventory creates similar concerns, although it is often not as financially concerning. Cash flow is seldom recognized as a fiscal problem. Inventory carrying costs can run 15–45% and interest rates are currently at historic lows. In the case of too little public services may suffer and many customers have few choices but to wait.
As the above illustrates, one of the areas in need of attention in the public sector supply chain is inventory management. Many public organizations do not measure inventory turnover rates, as inventory staff don’t see it as a key performance indicator. The skills required for good inventory practices are not as highly regarded as, say, negotiating the best price.
A few years ago, the inventory turnover rate for medical and surgical supplies in one Health Region was running at approximately 20 turns per year. Earlier this year I asked a health care manger within the same Region about their inventory turnover rate, and the reply was that turnover was no longer an issue – they never calculated it as it was not a priority.
This article is not a critique of public or private inventory management but illustrates how some leading practices can be adopted by any operation. In particular, we will examine cycle counts and turnover.
Daily cycle counts.
This practice has been in use for at least 30 years, yet we still find that many do not have any form of cycle count and still require an annual physical shut down to count SKUs. The count is then compared to the book value and repeated year-over-year. Could you imagine Amazon saying ‘we are shutting down for 3-days at year end to do a physical count’?
The benefit of cycle counts is knowing much more accurately what you have in stock and improving business processes.
Some of the questions I encounter on this topic include:
1. What are the basics of a daily cycle count?
2. If we don’t count all the SKUs every day, how can we count all of the inventory items?
3. Won’t auditors object?
Let’s look at an example:
You have 500 SKUs in inventory. The total value of the inventory is $225,000. Which SKUs are most important?
The A-B-C analysis is:
A SKUs are 20% of volume and ~70% of investment
B SKUs are 30% of volume and ~25% of investment
C SKUs are 50% of volume and ~5% of investment
A SKUs = 100 and are valued at $157,500
B SKUs = 150 and are valued at $56,250
C SKUs = 250 and are valued at $11,250
The rule of thumb for ‘A’ SKUs is to count these monthly; ‘B’ SKUs are counted quarterly; and C SKUs are counted twice per year.
So, using our example:
For ‘A’ items, if we work 20 days per month we need to count (100/20) = 5 SKUs per day; we only count 5 ‘A’ SKUs and reconcile to the book value daily. If we count and reconcile a different group of 5 ‘A’ SKUs each day, we will have counted all the ‘A’ SKUs, once per month. The reconciliation catches the order filling and replenishment errors on a daily basis.
For ‘B’ SKUs, working 60 days per quarter (150/60) = 3 ‘B’ SKUs must be counted and reconciled each day. Every quarter we will have counted all the ‘B’ SKUs.
For the ‘C’ SKUs, working 120 days per 6-months (250/120) = 2 ‘C’ SKUs must be counted and reconciled each day. This means that we will have counted all the lowest value inventory items twice per year.
Based on my experience most public sector organizations could even reduce the count for A, B and C SKUs by half – in other words, using our example, only count 3 A SKUs per day; 1 B SKU per day; and 1 C SKU per day. Following a relatively easy to implement daily cycle count will lead to better inventory management practices and eliminate the annual inventory physical count utilizing existing staffing resources.
Inventory turnover rates:
This key performance indicator is critical to private sector organizations. Although public sector does not record ‘sales’, the standard formula can easily be adapted for public sector by instead recording the value of goods issued, which is a routine report generated by the most basic ERP system.
Value of Goods Issued/Average inventory.
$620,000/$130,000 = 4.76 turns per year.
The average inventory is calculated by using the Opening inventory value + the Ending inventory value divided by 2.
There is a great opportunity for public sector organizations to do benchmarking on the inventory practice of daily cycle counts and inventory turnover. Benchmarking by like sectors makes the most sense, such as a school district with another school district or cities of similar size and locales.
With some expertise in inventory turnover tracking, you will find you can target turnover rates, improve job satisfaction by having more accurate counts, and provide better services with fewer stockouts and a lower investment.
When buying goods and services, equipment for businesses and government, and on any construction and infrastructure projects, a social procurement approach is one that would take into consideration the interests of the community stakeholders. This approach includes: social, ecological, environmental and economic development. Best value is achieved when we balance value-based interests along with pricing concerns.
When tendering a project with social procurement values, whether a domestic or a foreign contractor takes the contract, it creates positive competitive tension in the market. Social procurement values ensure social impact in communities once the project is initiated. Social impact is a measurable change on social issues or outcomes through procurement decisions. Social procurement is the transition from making goods deals, to making deals that do good.
Social procurement values have been around for a couple of decades but are receiving more attention through their success. Every organization consumes goods and services and these transactions are the everyday means of commerce. Social procurement is a specific strategy to ensure that local economic benefits are realized when contracting for goods or services.
Labour is an important factor in social impact outcomes. Individuals facing barriers, as one example, are often overlooked as a first choice for employment with for-profit organizations. This is understandable where peak efficiency is required to sustain profits. The result is many people facing employment barriers such as individuals having disabilities–rely more on social services paid for by taxpayers.
Would your organization hire an ex-convict? Likely not. However, Purpose Construction out of Winnipeg, does. As a social enterprise, Purpose Construction trains barriered individuals to qualify for construction work, pays them living wage rates, and helps them to return to full time work–often in the private sector. Social enterprises are social purpose businesses which generate value by providing goods and services-generally as a not-for-profit operation. Social enterprises provide meaningful work for people facing barriers to employment. This can include skills development to prepare the individuals for a return to the work force. Social enterprises work with government, private sector companies and with other social enterprises. Social enterprises are operated by business entrepreneurs.
The Purpose Construction example builds social capital in a community. Buy Social Canada defines social capital as the “relationships and networks within and among community members.” With a shortage of skilled trades, Purpose Construction can build a pool of workers to meet the demand in the market without government subsidies.
One of the early and continuing success stories in the social enterprise sector, is CleanStart Hoarding & Junk Removal CCC Inc. In the Vancouver lower mainland, CleanStart, in 2015, paid $233,000 in wages to its barriered employees. This resulted in a social return on investment (SROI) of $1M per year in the local economy. In 2020, CleanStart will contribute $1.4M. The SROI is based on a study by E&Y with Atira Property Management which shows that for every dollar paid to target employees, the return is >$4.00 in social and economic development! When was the last time you got a 4 to 1 return on an investment?
As a synopsis, the empirical study on the SROI demonstrated reduced reliance on social subsidies, reduced shelter costs, reduced criminal activities, taxes being paid back into community, increased local spending, increased employability, increased self-esteem, improved health and general quality of life. This moves these individuals from dependency on social services to independent taxpayers.
Another company which uses social procurement as a business strategy is Chandos Construction. They are the first and largest B Corp certified commercial builder.
Chandos is a Canadian, employee owned construction company operating in several major Canadian cities. Their social procurement strategy embraces: local employment, expanded diversity, poverty reduction, eliminating social isolation, local purchasing, skills training, first source hiring, and fair wages to underrepresented individuals. Chandos successfully responds to tenders for major infrastructure projects-which is a very competitive sector. Their commitment to social procurement values is another example of building social capital. Chandos recently brought on several workers facing barriers as full-time employees and enrolled them in the Red Seal training program for trades.
Purpose Construction, CleanStart and Chandos are great examples of social procurement being applied in Canada. It takes the spending power of buyers to make this happen. It also requires that buyers look beyond the lowest out-of-pocket cost and redefine the value proposition. As we move into the post-COVID era, it is even more important that we ensure that social enterprises and small medium businesses have a good opportunity to participate in government contracts. Government contracts are taxpayer paid. While we are engaged in a global economy, we concurrently need local economic diversity.
This implies not simply putting the bids on e-bidding platforms but using strategies which will increase the number of bidders. One tool is the unbundling of large contracts. The theory has been to buy the most from least to get the lowest unit cost. This strategy will always favour the multi-national corporations with the deeper pockets. Unbundling could take a percentage of the requirements and ensure local participation for the supply. i.e. targeting women-owned businesses or Indigenous contractors. The balance of the requirements goes to the lowest bidder.
We are dealing with many oligopolistic markets where the largest suppliers tend to control the pricing and availability. When we reflect on the PPE shortage during COVID, in part, this can be attributed to the bundling of the demand. Great pricing but as it turned out-no supply.
All trade agreements, international and domestic, provide for exceptions, exemptions, and exclusions when dealing with social enterprises by Federal, Provincial or Municipal governments. Further regional trade agreements provide for derogations for economic development strategies!
Community benefit agreements are an extension of the social procurement strategy. A CBA is an agreement between community, government, and developers that ensures development projects enhance local social, environmental and economic opportunities. The Parq Casino in Vancouver is a good example of CBA.
For the past 2-years, through Presentations Plus, I have been the procurement advisor on the Coastal Communities Social Procurement Initiative (CCSPI) on Vancouver Island. Along with Buy Social Canada, Scale Collaborative, and the Vancouver Island Construction Assoc., our role is informing public officials, training public buyers, training small businesses and social enterprises on social procurement strategies. This includes drafting bid document templates with social value language which focuses on increasing local opportunities and drafting policies. CCSPI began with 6 cities/towns and now has 20+ communities participating in this project. It’s very exciting to see the commitment from so many parties to common goals which are being realized.
The following table shows the difference from where procurement has focused its attention and the transition to social procurement values.
Consumption of resources
Conservation of resources
Make good deals
Make deals that do good
Ethic of Justice
Ethic of Care
It may be early days in social procurement, but I am pleased to say that more and more progressive organizations are adopting this strategy because of the compelling business case it creates. It’s about being vocal when making local the focal!
Procurement Policies in the Public Sector
Most people like to follow the rules. In many organizations, this could mean adhering to policies which lack current relevance to organizational and stakeholder needs. Playing follow the leader without challenging the status quo. Changing direction requires a procurement policy leadership strategy.
Image by: Mark Duffel
Procurement policies are often written as edicts under the assumptions that if everyone obeys, all will be well. Many policies are outdated and don’t reflect best practices or current market events such as trade agreement amendments or case law rulings. Informal “work around” processes may prevail. As social procurement is being adopted by progressive public sector entities, procurement policies are often lagging on this important means to affect values and outcomes.
The purpose of a procurement policy is to ensure the organizational values are reflected in business practices. For example, a City wants to adopt a Fair-Trade policy or a Province wants to ensure small and medium businesses have better opportunities to compete for its supply contracts. A Hospital could ensure social enterprises have a stake in providing work on the project for people facing barriers. These strategic outcomes are set by elected officials and or Boards. Therefore, outcomes need to be reconciled to policy and enacted in practice.
One of the best tools to ensure a policy is understood, is to provide staff with the how and why of a policy. The how and why is provided through a policy guide complemented with in-house training. While the guide is important for procurement staff, it is even more valuable for other decision-makers to apply the policy statements to their departmental needs. Suppliers look for consistency as to how policies and practices align. Consistency can create competitive tension.
For example, a department manager receives an unsolicited offer from a supplier, how should that manager respond to it? An example of a policy statement and how it is addressed in a policy guide are as follows:
Policy statement: Unsolicited proposal – A proposal from a supplier which has not been solicited through a competitive process.
Policy guide: Unsolicited proposals are typically submitted by a supplier who may also be able to supply similar goods or services as those in current use. The City should not consider these proposals further where they already have a contract in place. The City could, however, contemplate unsolicited proposals based on innovative practices or which use more responsible materials than are currently being used. In the short-term, the City may trial or pilot a program to evaluate the ideas further, without conflicting with existing agreements. In the long-term this could result in a competitive process being initiated to determine best value.
The department manager now has guidance on how an unsolicited proposal could be handled. It is respectful to the supplier, ensures the current contract is honoured, and allows a means to accommodate new ideas in the market under the City’s priority of need.
Policies also act as a means of risk mitigation. When staff are well-informed as to the policies of the organization, they will apply them consistently in their business dealings. A common risk is a misunderstanding of the basic principles of competitive bidding found in Contract A and Contract B obligations. Good intentions do not excuse non-compliance. A guide should reiterate the importance of Contract A and Contract B compliance along with other related competitive bid and contract management caveats.
Alternatively, when stepping out of the Contract A/B box to conduct a negotiated RFP a guide should ensure that staff are aware of risks and the correct process to use. Conducting evaluations often requires clear guidelines for objective outcomes to be fair and transparent.
Staff turnover compounds the potential for risk in bidding and contracting processes. The procurement policy guide increases the accountability for the designated authority, whether decentralized or in a centralized reporting structure. New staff can refer to a current guide when making procurement decisions. The guide mitigates the risk by having a searchable format readily available and updated annually. This implies, that the procurement policy should be reviewed on an annual basis. Staff training around a revised policy instils a better understanding of individual roles and responsibilities. If a city, as an example, is spending $50M or $500M per year for goods and services, there should not be an excuse of “I wasn’t aware of the legal obligations” when problems occur. It is incumbent upon the city to exercise all reasonable best efforts to ensure decision-makers are informed and as up to date as possible.
The commitment to social procurement has led to new opportunities in public sector strategies. Ensuring value for money is always the objective. Social procurement strategies are applied to increase social values and economic development outcomes while concurrently dealing with budget constraints. Social procurement practices within a policy are perceived as desirable and not mandatory, either-or options. A strategic outcome of social procurement practice is to build market capacity with social enterprises. A procurement policy which is inclusive of social procurement values encourages suppliers to adopt social procurement values and work with social enterprises. Social procurement is leveraging the existing spend to improve social outcomes. Again, the why and how needs to be provided within a guide for staff to appreciate the shift in the definition of value. Competitive bids need to have the appropriate criteria and weighting to affect change.
Ethical conduct in procurement requires an extra level of due diligence on the part of an organization to ensure fairness and transparency in its business practices. From declaring conflicts of interest in the procurement policy and how to clearly manage real or apparent conflicts during a bid process is part of the role of the guide. Not only is an individual’s integrity at stake but that of the organization itself.
An issue related to putting policy into practice is doing so in an apolitical manner. Individual beliefs or self-interests should not compete with organizational intentions. For example, the price variance between product choices. In one city, the environmentally responsible policy implied that cleaning products which contained volatile organic compounds (VOCs) should be avoided. However, products which did contain VOCs, at the time, were ~10% less. As the price difference could negatively impact the Facility Manager’s budget, the price-conscious manager went with the traditional cleaning product containing VOCs. His interpretation of the policy was one where the budget was the more important responsibility. After all, it was the taxpayer’s money. Therein, lies the rub. We now have an individual’s personal understanding of value being the proxy for the organization’s values. This is where the policy guide reiterates the need for clarity in setting the evaluation weighting so that the manager can proceed with a higher cost product-responsibly and ethically. The apolitical issue can be more problematic in decentralized organizations where authority is widely dispersed. This can contribute to inconsistency as to how a policy clause may be interpreted by the many decision-makers. Guides remove the doubt.
How do policies become ineffective? Summarily, out-of-date policies which do not meet the needs of decision-makers or external stakeholders; bureaucratic inertia developed by being overly risk averse; rogue buyers not being reprimanded for ignoring protocols; bid templates and related documents not reflecting best practices; oversight for the policy not being an organizational priority.
Purchasing card policies are part of a procurement strategy. The use of Purchasing cards also requires clear guidelines on best practices to ensure value for money and avoidance of fraud.
As a procurement advisor to the Auditor General for Local Government, on several occasions this author found large and small public sector entities with serious gaps in their procurement policies and practices. Many of these shortcomings led to the inability to assess value for money on multiple contracts and a lack of accountability as to how public funds were spent. Policies are effective where the people that put them into practice find them to be delivering on value.
Is your policy leading lemmings or providing leadership?
The author, Larry Berglund, has extensive experience in drafting and implementing Procurement policies, Procurement policy guides, full suites of competitive bid templates, and staff training to align policy with practice. He has assisted many organizations with the introduction of social procurement into policies and practices.
Lemming image found here.
Listen to an interview with Larry Berglund on PressResetWorld.com:
“Kat Nip interviews Social Procurement and Supply Chain expert, Larry Berglund about his new book on Social Procurement, “Plan It for Our Planet” You may not know about economics, but everyone knows about buying, so Larry will make this very easy for you to understand in an enjoyable interview, where you can see the importance of having social values attached to our buying habits. Larry has many examples as he tells about his journey from a traditionalist supply manager, to an advocate for Social Procurement. Topics: What is Social Procurement? What is Social Enterprise? Why is it critical to understand now? What values have we been operating under and how will that change? How is the Indivisible hand in the marketplace as important as the Invisible hand? What about Amazon? Where does government fit in? Where does business fit in?”
If you can’t see the forest for the trees, you may suffer from distracted management.
So many supply chain teams are operating with out-of-date policies, annual inventory counts mandated by internal and/or external auditors, competitive bid templates lacking adequate protection, and restricted staff training, or without monitoring supplier performance, having a contract management strategy, or being myopically focused on reducing costs.
When asked why, a common answer from department heads and front-line staff is that they are too busy “running a department to worry about whether a contractor has adequate insurance or not – it’s only a $5000 job! What could possibly go wrong?” Another frequently heard response is: “We’re too busy to get around to fixing it but we will – soon.” Soon never arrives, as it takes a backseat to tactical busy-work, such as Churning out RFPs under the illusion that the process will invariably lead to the best suppliers submitting the best proposals at the best price. This blind faith can lead to price fixing or collusion in the market. Smaller communities often are unaware that suppliers in the neighbouring communities won’t bid against each other – or will collude to skew the results or invite favouritism based on an address. Ensuring value for money is an imperative in any organization.
If you have heard these statements – you likely have distracted management setting priorities. These statements are not uncommon. The problem is, they perpetuate reactive situations based on tactical practices, rather than responses focused on strategic solutions.
I’ve gone into clients’ offices and talked to their procurement staff, our conversations often beginning with “So what are you working on?” and the common reply of: “We’re putting out a tender for copy paper” or “We’re getting ready to do our inventory count” or “We’re preparing for budgets” or “We’re getting ready for year-end.” These are good objectives – but they are also symptoms of distracted management.
The leading organizations are focused in eliminating paper; single-point data capture; rationalizing print devices; benchmarking against the number of print copies per staff person; and using milestones to measure progress. Daily cycle counts in large, small, private and public-sector organizations have been effective for around 25 years – yet many supply chain groups still conduct a draconian count of what is in stock and then wrestle with the inevitable discrepancies. This is a classic example of distracted management.
How do you know what you don’t know?
The speed of technology chafes against higher attrition through retirement and often leads to fewer heads and hands to do the work. There is a loss of knowledge transfer in the professional ranks. Hiring for competencies is a reasonable solution but typically only results in bringing the head count back to where it was, meaning that the way we are doing the work rarely changes.
Cooperative buying groups become trapped in contract cycles. While the work of issuing bids is spread among the members – the same repetitive sourcing tactics are deployed. Not a lot changes. Most of the ‘low hanging fruit related to price decreases’ was picked years ago yet bids are issued regularly for the same goods, often from the same suppliers left in the market, for marginal price concessions. By the time there are synergies gained between the end users and the new supplier, it’s time to go back to the market to try and squeeze further savings in the next contract cycle.
Few cooperative buying groups use a price index to measure their performance and to develop strategies. Supplier performance is almost a non-issue. A price-focused strategy of getting the lowest cost is the end game – period. Cooperative buying groups are tasked with finding annual savings against current budgets rather than best value. That’s what they know best. The tremendous opportunity to benchmark costs and processes available to public sector organizations is seldom considered – and one of the primary contributing factors is distracted management.
Lack of awareness of new technologies is a problem – we can’t plan for what we don’t know. Disruptive technologies such as bound metal deposition or intelligent quality systems affect cost structures globally. Are you adapting these? Others in the supply chain are.
Analytical methods such as activity-based costing studies (ABC) help to measure the cost of conducting business – administrative busy-work. Every organization should know the cost of issuing a competitive bid to ensure there is good value for doing so. If we have a good idea as to what the cost to issue a bid is, we have a good idea as to what our capacity is. When we want to find process savings, we now have a benchmark. Drafting templates designed for efficiency in process management makes economic sense. However, distracted management takes us away from these practices. We are too busy to get a template which meets the organizational needs due to the time it takes to put in the effort. We know it invites risk. This process works – until it doesn’t.
Leading organizations have relevant procurement key performance indicators KPIs, both financial and non-financial; use quality management techniques to improve practices; work with NGOs to affect value; make it easier for small medium enterprises to do business with them; use market sounding to assess competitiveness; prequalify contractors for efficiency; include the economic multiplier effect when assessing returns on investment; use qualification-based selection methods; use value-per-point evaluations; run integrated construction management strategies; utilize job order contracting software; involve fairness monitors to ensure good process management; develop contract management strategies; utilize constructability reviews to measure the probability for success involving construction; measure procurement’s performance against a price index; use vendor performance as a criteria; use total cost of ownership as a determinant of value; engage in social procurement; ensure a diverse supplier base; prepare for the circular economy; remain apolitical and professional; and look for leading practices on a continuous basis.
The cure for distracted management
Leading organizations realize that trying to do it all with in-house resources is a noble gesture but an impossible task, and so do not fall prey to distracted management. These organizations aren’t too humble to admit when they need help. They know they must have strategic objectives to ensure they are meeting their stakeholder expectations in principle and in practice. Leading organizations invest in the training of staff and provide the resources necessary for developing internal expertise and for learning from external expertise to stay current, competitive, and competent.
A reverse auction, also referred to as a procurement auction, is where the role of the buyer and seller are reversed. In a reverse auction, multiple sellers compete concurrently to sell goods to the buyer and / or provide services to the buyer, with prices dropping as the sellers out-bid each other to win the contract.
As the Internet emerged, reverse auctions were popular as a buyer’s strategy to drive down the prices on widely distributed homogeneous goods. Auto makers saw reverse auctions as another level of competition for automotive parts suppliers. Initially, the reverse auctions did reduce the prices on parts – once. The second generation of reverse auctions found fewer suppliers wanting to sacrifice their profitability. It was the big bang theory which had a limited life span as a price tactic. Once a new bottom was found on the lowest cost, subsequent price reductions had to be designed out of the products.
Incumbent sources often found themselves competing against their own price model to retain the business. Reverse auctions are effective only where there is an adequate number of qualified suppliers, who want the business – with quality being a lesser concern to the buyer.
The e-Bay online model uses the traditional auction format with a fixed-time period. The highest bidder takes the lot. Many public organizations use this type of e-auction service to sell surplus goods. One municipality found a ten-fold increase in potential bidders using traditional e-auctions to maximize the return when disposing of its fleet of police motorcycles. The power of the online format efficiently allows a seller to make contact with global bidders.
ERAs are now being used to acquire goods and services.
Preparing for ERAs
Third party ERA service providers are widely available in the market to facilitate transactions. Reverse auctions may require some training to develop effective techniques for buyers and sellers involved in the online process. Due to the current infrequency of ERAs, third party service providers could be a viable option to stage an event.
Market intelligence on the part of the buyer needs to ensure there is a pool of competitors among the potential bidders. A puddle of competitors favours the sellers or will result in few, if any, bids – similar to most conventional RFX events. Again, third party service providers already have online presence to expedite the events and have services to target specific sectors and build competitive tension.
Reported savings on ERAs (per US-based eBridge)
Southern California Casino reported savings of 42% off their budgeted spend. In a 1 hour and 6-minute event, 234 bids were submitted with the lowest bid changing 59 times. The winning bid was 1.96% less than the 2nd place bid.
A South Carolina school district reported a 10% savings on a $5M annual food services RFP. The lowest bid changed 34 times over the event.
A North Carolina hospital and affiliated university reported $900K savings over 5-years for records management services. The ERA involved (3) bidders which were pre-screened and took 1 hour with 27 changes to determine the lowest price. The spread between the lowest and next lowest bid was 1%.
An Arkansas college reported a $300K savings (17%) for an RFP on custodial services through an ERA event. It took less than 1 hour involving 10 suppliers and 186 bids. The spread between the lowest and the next highest was 0.65%.
One Canadian niche market for the use of ERAs is the Police Auctions Canada. PAC sells goods on behalf of several Ontario police services, Toronto Transit Commission, and (3) universities. ERAs run 24/7.
Electronic auctions are permitted conditionally under the CFTA: Chapter 5: Article 514; CETA Chapter 19.13. The United Nations, under its Model Law on Public Procurement conditionally allows ERAs under Electronic Reverse Auctions: Chapter VI.
Various other international organizations recognize ERAs as tools for government procurement agencies to increase value for its stakeholders. As more international trade agreements emerge, standards of practice for the rules of engagement become more relevant for all parties to adopt.
In Canada in February 2018, the Ontario General Contractors Association went on record as saying that ERAs are a form of bid shopping and contravene Canadian procurement laws; ERAs provide no real return on investment; the OGCA cited a US-based study which also refuted construction cost savings through ERAs.
However, construction materials as a category are regularly purchased through ERAs.
Caveats with ERAs
In summary, it is time to revisit the use of auctions and ERAs specifically. They are a tool which should be used judiciously – as we know, not every tool is a hammer. Used strategically, ERAs have their place in the market as another competitive tool to complement traditional bidding practices.
Our business decisions have been overly influenced for decades by the Invisible Hand theory. The Invisible hand is a term coined by Scottish economist Adam Smith over 200 years ago. The basic premise was that people will do business with each other in a free market which best decides the price of goods and services. An unfettered free market did not want any government intervention. When everyone works for their own self interests, we will collectively be better off, was the thinking behind the Invisible Hand.
We can see the shortcomings of the Invisible Hand which operated in a time with slave labour, a privileged few controlling commerce, harsh working conditions, child labour practices and an absence of environmental responsibility. Natural resources were seen as being infinite but worth fighting over. The Invisible Hand directed the growth of the Industrial Revolution.
Fast forward to today. In Canada, many of the shortcomings of the Invisible Hand have been eradicated in the marketplace. But not all. We acknowledge that government intervention is necessary to enforce responsible business practices. We complement the Invisible Hand with a term this author refers to as the Indivisible Hand of government. The Indivisible Hand guides and out of necessity, monitors the Invisible Hand to ensure social and economic interests are realized in a sustainable manner.
Any model which is primarily profit-based from a Supply side needs to be effectively balanced by the Demand side. Procurement practices, built on the Invisible Hand values, were aimed at attaining the lowest cost. This theory seemed to make sense until we looked deeper into the supply chain and found that the lowest cost came at the expense of social values and erosion of long-term economic development.
Business management training, until more recently was primarily based on Smith’s theory that as long as a product was legally sold, the market would set the price and should not concern itself with the public welfare – that was government’s job. Public sector procurement also followed the Smith theory, where the lowest cost from a tendering process must deliver the best value. Procurement decisions were largely one dimensional – economic interests first.
Quality management started to drive value which affected costs. Investing in quality management was primarily a means to ensure economic benefits would accrue. Environmental interests followed quality management rather reluctantly until we could connect environmental benefits with sustaining profits. Social procurement didn’t hit the procurement radar until the early 2000s.
Procurement, which is a transactional tool of the Demand side, needed to redefine the value proposition to go beyond the lowest cost and be based on values of a larger stakeholder base. Procurement in private and public sectors began realizing that the lowest cost was not a sustainable model. The Indivisible Hand, through legislation and by supporting international standards, has been transformative in affecting how we think of value. We need a three-dimensional model with economic and environmental interests meeting the expectations of stakeholders.
This has led to the emergence of value-based sourcing. Value-based sourcing is a more comprehensive decision-making approach which goes beyond the out-of-pocket costs. Where the objective of competitive bids has traditionally been focused on the lowest cost, the value-based approach is inclusive of other direct and indirect factors which influence value.
If we get the lowest cost from buying imported clothing and uniforms for our civic park staff, a city budget may see a savings on a line in their budget. What is not seen, may be the exploitation of the individuals that made the uniform or the environmental degradation in the country of source through the discharge of chemicals to dye the uniforms. Value-based sourcing or social procurement, requires that other factors be addressed. Factors which require that the uniforms are sourced from a supplier which is audited for compliance with ISO 20400 social procurement standards and / or ISO 14000 environmental standards.
The park’s budget for clothing may reflect a higher out-of-pocket cost but the price will be value-based. If we shop closer to home, we can see similar outcomes. If we source custodial services following the Invisible Hand model, we will identify several suppliers which will offer competitive prices and we can find one with the lowest cost. If, under the Indivisible Hand model, we set higher standards such as ensuring fair or living wages be paid to the employees of potential custodial suppliers, as buyers, a competitive bid will be awarded but the price will also be value-based. Stakeholder expectations are still being met. We know that the economic multiplier effect redistributes the revenues within the local economy.
Value-based thinking is critically important for government spending. With the billions of dollars spent annually for goods and services by various governmental departments, we need to ensure that a common set of values or principles are reflected in the award criteria. The message sent out in the tender criteria and weighting is reflected in the competitive responses. Awarding large contracts on a consolidated commitment, where only a handful of large multi-national corporations can supply, negates the opportunity for small medium enterprises and social enterprises to compete. This opportunity is enshrined within the Canadian Competition Act as follows: ensure that small and medium-sized enterprises have an equitable opportunity to participate in the Canadian economy. While arguably, a large bundled contract may yield the lowest cost, the other dimension of social development will offset the out-of-pocket savings in the long-term.
Having procurement engage with social enterprises to create meaningful jobs for people with barriers, contributes greatly to economic and social development. Ensuring that small medium businesses are economically viable in local communities builds social capital. Changing the idea from providing public welfare to supporting public well-being, is facilitated through social procurement practices.
The Invisible Hand favoured unfettered market transactions which benefited a small group of stakeholders. This led to the idea that profits should trump principles. The courts had to intervene to establish laws on conducting business. Business ethics and codes of conduct emerged to signal a change in behaviour and practices. The Indivisible Hand favours a market transformation which reflects the values of the majority of its stakeholders. The latter theory does not compromise principles or budgets. It does provide a better answer to the question – why did we buy that?
Much is being said about having a diverse work force. The message here is that a diverse set of skills, perspectives, and backgrounds, invites a broader view on any issues being discussed. This often leads to innovation, breaking out of complacency and finding options leading to better solutions to old problems. All good. Studies continue to show that organizations with greater ethnic and gender diversity outperform their competitors.
Where there is an affinity for values between the staff and the organization, the diversity supports a positive milieu. People know that their ideas will be weighed, even if their ideas are not adopted. They know that mutual trust and respect allow them to be creative and contribute beyond their pay grade. Their decisions will favour the whole rather than the few. Employees who feel they are being heard in the workplace typically put 4 times the effort into their work.
Employee engagement is one of the key outcomes of a positive workplace. Naz Beheshti, writing in ForbesWomen, states that engaged employees contribute 21% greater profitability. Its been shown that the 34% of engaged employees have 40% less absenteeism and 60% less turnover. Conversely, actively disengaged employees, those who have poor experiences in the work place, comprise 16% of the workforce – which is at an historic low, according to a 2018 Gallup survey. The other 50% of employees are not engaged – not cognitively and emotionally connected to their employer’s interests! This latter statement is quite astounding. This should cause leadership in organizations to reflect on building a culture which supports engagement, with diversity being one of the attributes to forming relationships.
The key to diversity bringing advantages to the organization is to have a common agreement on what value means. If people within an organization do not have a common concept of value, their diversity can lead to incongruence or passive engagement. As individuals, they will interpret value as they personally define it. As an example, is spending focused on the lowest cost or is it on the best value? Are profits to be realized by using any type of tactics? What would best value mean in your organization?
Procurement practices need to ensure that best value is the organizational view and not simply based on out-of-pocket savings. Without a common understanding of what value is, we invite bias in decision-making. Staff may choose to not buy products from a company because of a negative headline or internet story – regardless of what may actually have occurred. We lose the potential synergy found in diversity when we haven’t clearly defined value. The divergence of opinion on what value means, detracts from the collective actions.
Diversity in itself, is insufficient to drive values. The culture of the organization will need to demonstrate why diversity is important to its success in the future. Why does it matter that women’s roles in senior management increase as a % of employees? Why does it matter that LGBTQs staff are not being discriminated against? Why does it matter that ethical business practices be fair and transparent? Diversity in an organization is more effective where values are aligned across the workplace. 100% alignment would be nice but not realistic. Based on the statistics stated earlier, a target of 50% would be a significant achievement in employee engagement.
An organizational culture is affected by many external and internal factors and events. The role of the CEO or CAO is to ensure the values being expressed and corporate behaviour resonates with customers and stakeholders. The conduct of the leadership within the organization should consistently reflect the value or mission statement being espoused. We refer to this as the “video needs to match the audio.” Where an unacceptable behaviour, in the eyes of the customers or shareholders, is not congruent with the leadership message, there is often a disconnect by employees as well. The disengaged continue to be just that.
We see how SNC Lavalin, in light of its previous corporate missteps involving bribery, has been forced to change its leadership. SNC must renew its commitment to ethical values in its business practices. SNC’s shareholders and the market have spoken. The Canadian engineering company is exiting the lump-sum turnkey (LSTK) market which SNC identified as the root of its poor financial performance. This has resulted in a ~$1.9 B goodwill impairment charge and intangible assets impairment charge, as reported in their July 2019 press release. Values matter. Behaviours matter. Rogue practices cannot be tolerated – no matter the intentions. Organizational culture is shaped by social values and business practices. While SNC embraces diversity in its workplace, a few individuals compromised their values and principles in favour of their self-serving interests.
Workplace diversity is one of inclusivity and the benefits for this have been widely acknowledged. The ethical conduct of individuals also speaks to the corporate culture and tolerance. If employees, clients, or customers see the leadership not being respectful; or is only meeting its legal obligations; or is not “doing the right thing” – it sends a mixed signal which everyone hears. Senior leadership behaviour has a large impact on employee engagement. It’s the responsibility of the leadership to support the values in their actions with all stakeholders. A divergence in the opinion as to what the corporate values represent, can come at a tremendous cost to the organization and to the individual. This is particularly true at a time when skilled and disciplined procurement and supply staff are in short supply.
Wouldn’t it be great if you could buy everything you need from just one supplier? Only one contract to manage; only one invoice to pay a month; only one relationship to manage; only one performance to monitor; – the nirvana of procurement.
As it turns out – this type of procurement is starting to take place. The technology and distribution behemoth Amazon.com Inc.™ may be gearing up for just this type of business from government agencies. The Prince William School District in Virginia, USA plus 1500 other US public sector organizations have signed up to buy (10) categories of office supplies through Amazon-based companies. Only Amazon met the criteria of being able to supply all (10) categories. This involves literally billions of dollars in commitments. And likely the start of the conversation on what else can we buy from this A-Z supplier? As a colleague stated, Amazon doesn’t want to control the market, it wants to be the market.
Is this consolidation of governmental business from a single provider a US phenomenon? It doesn’t appear to be. In the UK, a similar strategy has been initiated by the Yorkshire Purchasing Organisation. Contracts include the proverbial “A-Z” from office supplies to medical equipment in a 5-year deal by aggregating (bundling) demand to “drive the cost of goods down.” The estimated value is £600M ($976M CDN) through an Amazon-based partner. It is highly probable this buying trend will take place in Canada. This could arise through the entry of US-based group purchasing organizations.
This is really an extension of the tactic of bundling goods into larger and larger volumes in order to get the ϋber lowest cost. Canadian public procurement officials have been pursuing this model for years. Witness the many oligopolistic markets which are in place today. Food, pharmaceuticals, airlines, transportation, toys, fuel, couriers, concrete and yes, office supplies. A handful of suppliers control the quality, price and supply, which is the definition of an oligopolistic market resulting in limited competition.
Provincial shared services agreements and cooperative buying groups follow a similar agenda. To paraphrase, they buy as much as possible, from as few as possible, for as many as possible, for as low cost as possible. Net result – initial contract savings seem to wow the Owner. Only the bigger suppliers can meet the demand side expectations. This pushes out the small, medium enterprises. When SMEs go out of business this is not the responsibility of the government buying groups – it’s not in their mandate to be concerned with the outcomes of a zero-sum game. It’s just what happens in the market. The next time the Owner (buying group) goes out to the market – only one or two suppliers may able to submit a bid for the volume of bundled goods and / or services, aimed at the lowest cost. At this point, how would the Owner assess the value for money? An oligopoly is hard enough to negotiate in – a monopoly is a futile exercise. This can result in limited levels of competition and limited bargaining power for the Owner in the long-term. Social costs are external to the sourcing strategies but are borne by the same taxpayer.
Woodwards and Eatons were the canaries in the retail market when Wal-Mart and other US Big Box companies came to Canada 25 years ago. Wal-Mart et al drove out the larger Canadian retailers and continued to steam roll over the SMEs. Some hand wringing by politicians took place and protest groups but no real push back. After all, the end seemed to justify the means – cheaper is better. The obsession with the lowest cost of goods is a trait of the consumer and perhaps the public sector. Both sides have their own rationale.
Consumers buy whatever is legally available within a market and focus on their own interests. For government buyers, there is an expectation that they will make decisions based on value for money for the public good. Given that society benefits from various health care and social services, which are paid for by the taxpayers, public sector policies need to consider more than the lowest out-of-pocket-cost. It is fairly intuitive to see that if we all buy from a non-Canadian supplier, a redistribution of revenues will favour a foreign-owned, low cost entity. We may draw the line at the working conditions or human rights violations. We could argue that this all a part of the free trade system.
A rather innocuous appearing procurement tool is the P-card. It was intended to reduce the administrative costs for buying low value goods. Enter Amazon. Based on conversations with procurement professionals in the public sector, they are seeing staff and managers searching the Amazon site for deals. Their only measure of value is their budget. If it costs less to buy an item from Amazon, they are doing a good job. Their time isn’t included in the search. Shipping may be. Duties may be. It’s what gets charged to their P-card that matters.
Which causes us to reflect on local sourcing opportunities and trade agreements. In discussions with procurement colleagues in the Lower Mainland of BC, conservatively there could be $300M per year in spending through P-card programs within this public sector. We can’t have local preference for suppliers under the trade agreements but when we think of the P-card flexibility, there are options. Referring to the Lower Mainland values, if only 10% of the P-card buying was redirected at local suppliers, this could redistribute $30M to locally owned and operated businesses. It doesn’t negate trade agreement obligations. To an SME sector, $30M is a meaningful amount of money. Public sector organizations may need to look at their P-card guidelines and ensure that local sourcing is the first option and foreign-online is not. Multiply the example dollars by the rest of the Canadian market and it becomes a significant dollar value. It does require a conscious change in spending practices.
In terms of the market, these are still early days for mass online ordering by government operations. However, the buying patterns and trends are starting to show. The potential material savings have not been measured against the long-term social costs. Government has at least two pockets to balance – the spend pocket and the revenue pocket. If these get out of balance, we lean towards deficits. The time is now to ensure our government sourcing strategies are cognizant of the A-Z supplier implications.