Building Purchasing Capabilitiesin an Economic Downturn

1
Building Purchasing Capabilities in an Economic
Downturn
September 29th, 2009
2
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?

3
Our clients results have built Bains track
record of success

• Bain is one of the worlds top management
  consulting firms, advising global leaders on
  their most critical decisions including
• Work with over 4000 companies, including more
  than two-thirds of the Global 500
• Consulting on half of the largest global private
  equity deals in the last decade, with funds
  representing 75 of global equity capital
• Bains mission is to help management teams create
  such high levels of economic value that together
  we redefine our respective industries
• Bain is recognized for our innovation and
  breakthrough business insights
• Developing cutting edge approaches to growth,
  business transformations, performance
  improvement, customer loyalty and organization
• Creating industry-leading spin-offs
  includingBain Capital and The Bridgespan Group

4
Founded in 1973, Bain brings a global network to
serve your needs anywhere
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The knowledge and experience of each of our
4,800 employees across 41 offices are shared by
all of us
5
Bains purchasing expertise spans industries and
geographies
Source Bain Global Experience Center, updated
11/17/08
6
We invest in Purchasing research and publish our
findings in top magazines and journals
Purchasing best practices research
Example Purchasing articles
Organization performance
High
Middle
Low
Attributes of a high performing organization

• Benchmarking conducted with over 160 companies
  through EIU
• Currently incorporated into our Purchasing
  Assessment tool, which enables benchmarking
  against others

7
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?

8
Purchasing is a large, if not the largest, cost
category in most industries
Note Other includes Computer Hardware, Computer
Software, Consumer Products, Media and
Transportation ServicesSource CAPS Research
Cross-Industry Report of Standard Benchmarks
Published October 2008
9
However, we observe important performance gaps in
the way leaders and others manage purchasing
Only 15 of companies have world-class
purchasing capabilities
Leaders outperform across multiple purchasing
dimensions
Leaders defined as having an average score of
3.5 or higher for Word class purchasing
capabilities and Costs are as low as they can
beNote 4 Strongly agree, 1 Strongly
disagree Average leaders score includes all
categories except the two used to identify
leadersSource Performance Improvement
DiagnosticsSM- Management Survey Results, June,
2008. N60
10
Recessions create heroes and casualties. . .
Winners
Laggards
Laggards
Note Performance ratings are based on a
combined measure of net profit margins, sales
growth, and Total shareholder return.
Recessionary period 2000-2002 Winners defined
as companies in bottom moving to top performance
ranking Laggards defined as companies in the top
performance ranking falling to the bottom Source
SP Compustat Bain Analysis
11
Top Winners in the last recession tackled
purchasing aggressively
Winners were able to reduce relative COGS costs
and purchasing has been a key enabler to
reducing COGS
Nissans sharp focus on thoroughly
implementing cost-cutting measures, such as using
common platforms for different automotive models
and reducing the cost of auto parts procurements
by 20 percent, has been the major contributing
factor to the company's turnaround. Daily
Yomiuri, October 2002 We are gratified to see
the dramatic improvement in our profitability in
the first quarterBetter sourcing and more
efficient manufacturing have led to a
210-basis-point increase in our gross margin.''
J. Hicks Lanier, Chairman Oxford Industries,
September 2002
Note Top Winners defined as companies in bottom
quartile rising to the top quartile Top Losers
defined as companies in the top quartile falling
to the lowest quartile Quartiles are based on a
combined measure of net profit margins and sales
growth. Share of companies with lower COGS
during recession calculated by comparing the
average COGS between 1999-2000 to the average
COGS between 2001-2003 Source SP Compustat
Bain Analysis
12
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?

13
Many companies struggle creating lasting
Purchasing results
Typical approach
Bain Approach

• Size cost reductions with an exhaustive top-down
  bottom-up approach utilizing tools like scale
  e-curves, make vs. buy analysis

• Tactical, bottoms up identification of targets

• Focus on total spend, and identify quick hits by
  controlling demand and indirect spend

• Focus only on most visible direct categories,
  leaving large portions of spend under-managed
  (e.g. indirect, services, CAPEX)

• Improve competitive position by consolidating
  integrating with key suppliers, while assessing
  Total Cost of Ownership

• Transactional relationship with all suppliers
  (i.e., squeeze all suppliers on price in every
  order)

• Proactively manage risk utilizing strategic,
  operational, and/or financial levers

• Hedging all volatile categories

• Limited collaboration between functions,
  inconsistent decision rights, and late purchasing
  participation in new product development

• Align purchasing organization with strategy,
  corporate structure, supply market and embed
  decision processes, roles, rights

• Invest in spend management, eProcurement,
  eSourcing tools while tracking performance to
  ensure sustainability

• One-time effort, underutilizing IT tools to
  manage spend

14
Bains three-step approach to Purchasing and
Supplier Leadership avoids the typical pitfalls
3. Sustaining benefits
2. Seizing the Prize Quick hits and firm
footing
1. Sizing the opportunity
Top-down gap e-curve, scale curves, make vs.
buy etc., to identify top-down competitiveness gap
Control demand by deferring purchases or setting
policies
Strategy Purchasing aligned with company
strategy
Category knowledge management and performance
tracking category strategies developed with
market and internal facts
Consolidate volume across suppliers, BUs, and
geographies
Bottom-up gap Identification of category
opportunities thru quick analysis and prior
experiences
Increase competition globally, locally or
internally (i.e., make vs. buy)
Processes and decision rights Clear roles and
responsibilities for key decisions
Simplify design and substitute to reduce
complexity costs
Validate through benchmarks Compare prices,
terms and conditions, quality standards, and
innovation options
Integrate with supplier to reduce joint total
costs
Organization and people Aligned with supply
markets and internal structure
Control and hedge risk to actively manage exposure
15
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

16
Scale curves can demonstrate benefit from
supplier consolidation

CLIENT EXAMPLE
Example Supplier Consolidation Effect of
Increased Volume on Price-Metal Components-
PriceUS/unit
Price-Volume Curve
200
167.8
151.2
-13.1 with an expected volume increase of 82
154.3
150
143.4
145.8
141.1
135.1
100
100
150
300
200
250
Volume(Index)
Source Bain Purchasing Practice
17
An experience curve shows how much unit prices
and costs decline as experience is accumulated
Factors underlying the experience curve

• Learning curve individuals and companies learn
  to do their jobs better and more efficiently over
  time
• Competitive pressures continuous efforts of
  companies to manage their costs or serve their
  companies more effectively over time
• Economies of scale as industries mature and
  companies grow/consolidate they enjoy greater
  economies of scale

Cost
Accumulated Production
18
Example of experience curves (e-curves)
19
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

20
Our approach and levers for procurement total
value impact
Total Value Impact
Variability Impact
Volume Impact
Unit Cost Impact
Revenue Impact
Supplier Unit Costs
Internal Unit Costs
Joint Unit Costs
Suboptimal Scale
High Margins or Factor Cost Differences
Control Hedge Risk
Control Demand
Consolidate Volume or Outsource
Increase Competition
Simplify Design Substitute
Integrate w/ Supplier
Supplier-led Innovation
Risk Mgmt Process
Demand Strategy Process
Supply Strategy Process
RFX Negotiation Process
21
A 4-phase approach to develop sourcing strategies
should be followed
1.5-2 months
1-2 months
2 months
2 weeks
I - Supply and Demand Strategy
II - Define Tactics
III - Implement
0 - Setup
Analyze and Develop Supply Strategy
Conduct RFX Negotiations

• RFI
• RFP
• Negotiations

• Supplier consolidation
• Supplier collaboration
• In vs. outsource

Initiative Setup
Implement New Strategy

• Team
• Agenda
• Workplan
• Data request
• Logistics

• Contract
• Integration/ implementation plans

Analyze and Develop Demand Strategy

• Control of quantities
• Unit cost reduction thru simplification,
  standardization, etc.

22
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

23
The first step is to define objectives by setting
specific and measurable terms
Illustrative
Cost
Quality
Availability
Innovation

• Limit category spend to 15 of total direct
  material costs
• Set annual cost reduction targets equal to 12
  based on experience curve

• Ensure quality will not impact companys
  production yield by more than 1

• Increase availability of category to 99.5 by Q2
  2009

• Ensure 200 supplier-led innovations (e.g., end
  products, input parts, cost reduction, processes,
  etc.) per year

Note Quality, availability and innovation
objectives may also result in cost reductions
(secondary purpose)
24

Four key parameters shape procurement strategy
1
Number of suppliers

• How many suppliers should the client have?
• What drives fragmentation vs. consolidation?
• What supplier capabilities will be required?

Fragmented supplier base
Concentrated supplier base
2

• How should the client engage with its suppliers?
• How will pricing be structured?
• How much collaboration on design/process cost?
• How will client manage addition of new capacity?

Supplier relationship
Collaborative (i.e., VMR)
Arms length
3
Make vs. buy

• Should the client own capacity/IP?
• What benefits are derived from captive capacity?
• What are the costs?

Out-source
In-house
4
Supply Market

• Should the client establish a global or local
  relationship with suppliers?
• How is the supply market structured?
• Are there scale or coordination benefits?

Local
Global
25
Perform key industry analyses
1
2
3
4
5
6
7
8
26
Results of the analysis help determine the four
strategy parameters
1
2
3
4
1
2
3
4
5
6
7
8
27
Share of industry/supplier
1
Market map by customer
Revenue by customer trend
28
Supplier profitability
2
EBIT margin by supplier
Industry profit pool
29
Scale impact on cost
3
Experience curve
ROS/RMS
30
Company/supplier interdependencies
4
Collaboration framework
Examples of collaboration
31
IP/technology differentiation
5
Assessment of ability to protect IP
Technology trends
32
Switching costs industry-wide standards
6-7
Industry standards analysis
Switching cost analysis
33
Supply base geographic concentration
8
Supply Concentration for Key Regions
Supply Base Geographic Structure
34
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

35
Need to understand spend and costs per SKU

Client Example
Total

bottle

costs
190

M

88M
38M
100
Building
Vendor
6
Gross

Margin
Electricity
Vendor
5
Vendor

5
Building
Equipment
Electricity
80
Vendor

4
Equipment
Labour
Vendor

3
Labour
60
Vendor
2
40
Raw

materials
Raw

materials
Vendor
20
1
0
In-house

blown

bottles
Finished

bottles
Other

finished
(Consolidated)
bottles
90M
208M
N/A
Total

pounds
36
Driver trees indicate where value lies
COMPANY X EXAMPLE
Number of phones

• 830 mobiles
• gt50 of salaried employees
• 331 accounts lt50pm (may include family members
  on employee scheme)

Average call cost per minute

• 27c per minute
• cf. 24c at Bain (40 users)

Spend __M
x
Average spend per user
x

• Top 20 users average spend gt500 per month
• Highest average 727

Average minutes of calls out per month

• Average across whole business 116 per month

37
Driver tree example
First Classonly for CEO
Route dealsfor BusinessClass fares
Reduce tripsto US/UK
Stay at lowerclass hotels
38
There are six levers to optimize internal demand
1. Procure to pay controls
Control Demand
2. Forecasting inventory management
3. Reducing waste
Demand Strategy
4. Standardize
Unit Costs
5. Substitute for lower cost alternative
6. Simplify design
39
Control demand by identify key issues in the
procure to pay process
1
Procure services and pay vendor
Set policies/ budgets
Pre- approve spend
Approve expenses/ spend
Track Review
Revise policy
Check expenses
Potential Issues

• No specific guidelines on many areas
• No limits set
• Unclear process
• Incremental budget setting

• Flexible managerial authorisation
• Lack of accountability

• Unclear communication on booking method and
  priority suppliers
• Not the lowest rates
• No specific limits on spend
• Lack of accountability

• Flexible managerial authorisation
• Lack of accountability

• Little structured tracking and reviewing on most
  areas

• Unstructured process
• Unclear accountability

• Lack of clear guidelines allowing some excessive
  expenses to be reimbursed

Are there clear spend guidelines? Are budgets
zero based? Are policies communicated regularly?
Is there an appropriate approval process and
sign-off limits?
Do managers add value to their signatures?
Does accounts payable play a controlling role?
Key Questions
Is there a tight procurement process?
Is there a line-by-line review every month? Are
variances driven through to tangible actions to
track?
Are policies reviewed on a regular basis?
40
Statistically Managed Inventory (SMI) calculates
optimal safety stock for a given service level
2
Average inventory is the sum of safety stock and
½ cycle demand stock
Safety stock needs to cover for supply and demand
variances
One replenishment cycle
Inventory level
Avg. inventory level
Cycle stock
Safety stock
Time
LT variation with constant demand
Service level factor
Demand variation during LT
St Stock level at certain time WSt Working
Stock SS Safety Stock
LT Lead time for replenishment s2d Forecast
Error variance d2 Forecasted demand in
replenishment cycle s2LT Lead time variance
41
3
Scrap and rework can be an important demand cost
driver
42
Significant SKU complexity is driven by weight
and neck specs
4

Weight
Neck Finish
CLIENT EXAMPLE
Shape
Color
Note Includes both bottle purchases and in-house
production Source Operations
43
Substitution can also impact total cost
5
CLIENT EXAMPLE
Example substitution Substitution of PET for
HDPE bottles
Top 4 SKUs represent 40 of the opportunity
Note Assumes standardized gram weight for each
container prices based on the most competitive
RFP bids
44
Design simplification can generate important
savings
6
CLIENT EXAMPLE
Simplifying specifications
resulted in a 30 decrease in carton costs
and also passed on benefits to supplier

• Composite printing
• Colors reduced
• Fewer key lines
• Board variety reduced to one type
• Base material costs
• Thickness down 30
• Strength increased
• Outer case and varnish replaced
• Transport costs
• Pallets reduced (500 to 100)

• 30 volume growth
• 60 set up cost savings
• 50 transportation savings
• Less material costs and waste
• Long-term relationship with stable margins

Source Bain Purchasing Practice
45
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

46
Supplier selection criteria can be defined in a
workshop
Request for Proposal
Selection Criteria
5. Legal Confidentiality
4. RFP Response Temp.
3. Evaluation Criteria
2. Overview of Spend
1. Introduction
BOTTLESREQUEST FOR PROPOSAL Client June, 2009
47
RFP results will need to be summarized, and
validated with the core team to select suppliers
for face to face negotiations
CLIENT EXAMPLE
48
Suppliers will be selected for negotiations based
on evaluation criteria previously selected
CLIENT EXAMPLE
Supplier A
Supplier B
Supplier C
Impression of the supplier during tender
process (Matching of offer and tender, defect
frequency in offer, quality of supplier queries)
Price (Final price (TCO) for entire purchasing
volume)
Other distinguishing features (Proximity to
suppliers, language barriers, Made in Germany,
delivery and payment conditions, purchasing
conditions, consignment stock, etc.)
Production standards (Employee skills, quality
quantity of machines, experience with
manufacturing similar products, process
reliability, certifications)
Control standards (Employee skills, existence of
climatic chambers, know-how of testing similar
products, software programming)
Strategic fit with the client (Does the
suppliers strategy fit the clients strategy,
possibility to benefit from supplier when
improving own products)
Suppliers selected for negotiations
Excellent
Sound
Okay
Poor
49
eAuctions are only to be used in adequate
environments
Competitive market environment for product?
Adequate IT platform available?
Employees with necessary skill set available?
Tender volume large enough?
Sufficient time?
Required documentationavailable?
Enough relevantsuppliers identified?
Suppliers respondto online tenders?
eAuction preferable
50
The second step is to identify key negotiations
parameters, and their objectives
Most Desired Outcome (MDO)
Least Acceptable Agreement (LAA)

• Level of savings FoodCo will task each supplier
  for, recognising that it will not necessarily be
  achieved in all instances

• Minimum level of savings considered acceptable
  from each supplier
• May not always be achievable but if not achieved,
  sign of unsuccessful negotiation

51
For each supplier, teams should identify
negotiation messages
Hot Buttons
Benefits
Decision Maker/Title
Benefits from a business relationship with us
Role(s)
This Persons Hot Buttons
Persons Receptivity to our MDO
Benefits from Addressing their Hot Buttons
Our Leverage
?
Customer Objectives/Criteria

Messages
Issues
MDO
LAA
Import.

Improve acquisition cost
X
A
?
Consolidation with us is win-win
?

Consolidate supply base volume
C
X
Lower total cost is result of accepting our
bundle
Improve product merch.

A
X


Improved lift and turns

Aligned corporate/merchandising

Negotiating Issues/Levers
Potential Actions
Plan for Negotiating Session
Objectives
Value of long-standing relationship
Need to create barriers for moving our existing
business and Incentives for moving us into
another suppliers category
Product/service value (cost/quality equation)
Team
How we can help them to be more profitable
Timing
52
Negotiations team role preparation

• Typical Core Team roles include
• Lead negotiator leads negotiations, providing
  single voice for the supplier client
• Senior representative serves as authoritative
  decision maker of organization
• Technical representative listens for end-user
  needs and future demand
• Observer/Scribe/Process Checker provides
  detailed notes of all discussion, agreements, and
  issues
• Additional extended team members may be involved
  at appropriate junctures
• These roles are not necessarily unique (i.e., one
  member may play multiple roles), nor are all
  roles required in every negotiations or every
  round of a negotiation
• Each role will have specific responsibilities
  which should be planned in advance

53
Overcoming barriers your emotions
In the preparation process, it will be important
to also review soft tactics

• Recognise the danger signs in the discussions
• Personal attacks
• Trickery (e.g. manipulating data)
• Avoid your natural reactions
• Striking back
• Giving in
• Terminating discussion indefinitely
• Buy time dont be forced into a quick decision
• Pause and say nothing if need be
• Replay the conversation to buy more time So
  what youre saying is
• If youre still not thinking straight take a
  break

Source Getting Past No, Negotiating Your Way
From Confrontation to Cooperation by William Ury
54
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

55
The buyer should update a savings report
Client example
56
Signed contract serves as evidence for savings
DISGUISED CLIENT EXAMPLE

• Key learnings
• Use copies of signed contracts to give legal
  evidence to every finished initiative
• Integrate a screenshot of the signatures into the
  loop for the clearing meeting with the client
• Have the complete contract ready as a backup in
  the clearing meeting as paper copy
• If there is no contract, use reports from the ERP
  system or emails from the supplier to prove the
  new prices

57
Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

58
Commodity businesses are exposed to various risks
- price and supply risk most relevant
Type of risks in the commodity market
Supply risk
Counter party risk
Other risks (currency,country,operational, etc.)
Price risk

• Risk of being exposed to volatile commodity
  markets
• Uncertain margins within the integrated value
  chain

• Risk of being imbalanced in raw material supply
  and demand
• Short in raw materials
• Shut down of operations
• Operation without optimized commodity mix
• Long in raw materials
• High inventory level/ cost of capital
• Limited shelf life

• Risk of default of trading/supplying counterpart
• Depending on financial standing/ reliability of
  counter party

• Risk of unexpec-ted changes in foreign currencies
  traded with
• Risk of changes in the political or economical
  situation of a supply country

59
Price risk assessed along 3 dimensions
Correlation
Time lag
Volatility
?-Factor analysis
Cross-correlations
Correlation matrix
Crude
Naph-tha
Ethy-lene
HDPE
PP
PO-basket
1990 1995 2000 2003
0,45
0,4
Crude
1
0.96
0.68
0.31
0.28
0.29
0,35
0,3
Naphtha
-
1
0.74
0.41
0.34
0.39
0,25
Correlation
0,2
Ethylene
-
-
1
0.76
0.60
0.70
0,15
0,1
HDPE
-
-
-
1
0.85
0.96
0,05
0
PP
-
-
-
-
1
0.95
-150
-100
-50
0
50
100
150
Lag
PO-basket
-
-
-
-
-
1
Correlation (time lag 0) 0.39
Correlation (max) 0.39
Time lag 23 days
Limited correlation
Consideration of time lag does not increase
correlation
Volatility has decreased recently
Alternatively spreads or multiples could be
analysed
60
Metrics to measure risk VaR most common

Value at Risk (VaR)

• Measures downside risk
• Provides maximum loss potential given a certain
  probability and time period
• Based on statistical model (historical values or
  Monte Carlo Simulation)
• Specific alternative measures can be Earnings at
  Risk or Cash-flow at Risk which do in fact
  not deviate from the more general term VaR

Sensitivities

• Measures change in value of a position (or any
  other dependent variable) given a 1 change of a
  risk factor several measures in place, often
  referred to as the greeks e.g. delta, gamma
• Provides monetary impact of one slightly
  deviating risk factor w/o consideration of
  probability and interdependencies of multiple
  risk factors

Volatilities

• Measures spread of possible outcomes (e.g.
  variance)
• Provides variance of results (downside and upside
  not differentiated)

Lower Partial Moments

• Measures risk to fall below a certain benchmark
  for a specific value
• Provides probability of shortfall (as well as
  magnitude and variance of shortfall)

Semi-variance

• Measures variance of negative deviations from
  the mean
• Provides variance of results with negative
  deviation from mean

Value at Risk is an intuitive and commonly used
risk measure that quantifies exposure and
uncertainty of risk in monetary units and
accounts for interdependencies between risk
factors
61
Value at Risk models quantify the price risk

Historic scenario

• Price commodity 1
• Price commodity 2

0,14
Historic price database
0,12
0,1
0,08
0,06
0,04
0,02
0
1400
1200
1000
800
600
400
200
0
Cash Flows
Model relations
Strategy
Value at Risk

• Sourcing/selling pattern (volumes)e.g.
• Pricing mechanisme.g. PButane 0.85 x PNaphtha

Frequency ()
5
CF
Scenario 3
CF
CF
0,14
0,12
0,1
Z
0,08
0,06
Z
0,04
Total Cash Flow
VaR
t
0,02
0
Assumptions

• Material conversion factors
• Initial product prices
• Time horizon
• Confidence level
• Random runs vs. complete consideration of
  historic time series

62
Define desired risk profiles together with top
management

Price risk profile
Supply risk profile
Question

• What is the maximum sustainable/desired level of
  price risk exposure?

• What is the maximum sustainable/desired level of
  supply risk exposure?

Measures

• Which shortfall in cash flow from operating
  activities can be overcome (short-term)?

• Which shortfall in supplied raw material volumes
  can be overcome (short-term)?

Parameters

• Historic volatility of prices
• Considered period

• Probability of undersupply

VaRmax 15
Baseload supply volume 90
Indicator
The contractual supply volume with raw materials
shall cover 90 of the expected consumption
The shortfall in cash flow shall not exceed 15
from expected cash flow(less than once in 4
years)

VaR calculated for next 3 months on basis of
historic prices of last 5 years
63
There are a number of ways to create control or
accommodate unpredictable inputs
Risk management tools
Strategic tools
Financial tools
Operational tools

• Pricing
• Create mechanisms to pass along input cost
  increases
• Business unit or project selection
• Achieve target risk/ volatility through an
  efficient mix of projects/businesses
• Vertical integration
• Control exposure through the direct control of
  inputs

• Flexible production
• Shift to input substitutes or build inventories
  when prices are favorable
• CAPEX/expenditures postponement
• Accommodate input exposure

• Forward contracts
• Lock in price via fixed contracts
• Option contracts
• Offset price volatility with financial instruments

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Risk management policy needs to cover7 building
blocks

• Organizational structure and responsibilities
• Board of directors
• Trading desk(s) definition
• Back office set-up
• Disclosure obligations

1

• Back office policies and procedures
• Deal inputs, edits, audits, confirmations,
  documentation
• Risk monitoring and management
• Cash management A/P, A/R
• Records management

4

• Interface to accounting/tax
• Accounting P/L policies and contracts
• Valuation calculations/methodology
• Tax policies and contracts

5

• Employee requirements
• Background
• Training
• Trading limits
• Code of conduct incl. acknowledgement

2

• Legal requirements
• Regular alignment with market practices and law
• Enforceability of transactions

6

• Risk exposure guidelines/limits
• Overall guidelines on physical and derivative
  activities
• Authorized products/counter parties and
  associated limits
• New product/counter party approval guidelines

3

• Internal control and self protection
• Internal contracts
• External verification
• Third party review

7
Source Literature
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Implement continuous risk management monitoring
cycle
Risk quantification
Risk identification

• Quantification and evaluation of identified risks
  with useful risk metrics
• Dimensions
• Correlation
• Time lag
• Volatility
• Measurement
• CFaR, VaR
• Sensitivities
• Volatilities

• Recognition and categorization of existing risks
• Identification of underlying risk factors
• Price risk
• Supply risk
• Counter party risk
• Other risks

Risk monitoring
Risk controlling

• Continuous monitoring of efficiency of applied
  risk management instruments
• Review of conformity of overall risk management
  process with risk management policy
• Review of assumptions of risk management strategy
• Assessment of new emerging risks risk
  management instruments
• Adjustment of risk management strategy to
  changing market conditions and new risk-return
  targets

• Selection of instruments and measures to limit
  risk exposure according to a predefined risk
  policy
• Strategies
• Avoid
• Hedge
• Accept
• Leverage (speculate, arbitrage)

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Agenda

• Introduction
• Why is Purchasing important in an Economic
  Downturn?
• What is Bains approach?
• Sizing the Opportunity
• Seizing the Prize
• Supply Analysis and Strategy
• Demand Analysis and Strategy
• RFX Negotiations
• Implementation and Tracking
• Managing Risk
• Sustaining the Benefits

67
The right organization needs to be in place to
ensure total cost sustainability
Total Purchasing Costs over Time
Total Costs ()
The Rest
Leading Organizations
Time
Focused efforts launched
68
We build together a World Class Purchasing
organization
Strategy

• Purchasing aligned with overall strategy
• Aggressive and objective value aspirations around
  cost reduction, innovation, quality and service
  targets
• Purchasing works with the rest of the business as
  one team

Processes and decision rights
Organization and people
Knowledge management performance tracking

• Clear decision-making roles/responsibilities to
  ensure high metabolism
• Consistent supplier governance model by tier
• Processes codified, embedded in the business, and
  supported by standardized e-tools, templates and
  systems
• Focus on cycle time and process variability
  reduction (six sigma)

• Purchasing aligned with corporate structure and
  supply markets
• Strategic and tactical purchasing decisions
  properly separated
• Adequate investment in talent sourcing and
  development

• Spend factbase in place, opportunities identified
  and prioritized
• Spend analytics and market intelligence
• Progress against key priorities tracked through a
  holistic management information dashboard

69
Building Purchasing Capabilities in an Economic
Downturn
September 29th, 2009