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In Search of Best Value

March 21st, 2007 · by Tim Minahan · 6 Comments · best practices, costing, sourcing, supply management

A Supply Excellence reader comment to yesterday’s post reaffirmed the sense I’ve been getting from recent conversations with supply management executives: Everyone talks about best total value supply. (You can’t puruse a software vendor’s web site — including my employer — without being accosted by value terminology.) But few truly understand what best-value supply is. And even fewer are negotiating and managing supply relationships for best total value.

The comment came from a supply chain manager who is employed at major third-party logistics (3PL) provider. His point focused on the issue of balance-of-trade and how having a supplier is also a customer must be factored into overall sourcing and supplier management strategies, but it reinforces the difference between lowest total cost and best value supply.

“I have found that procurement folks tend to live in their own world. When we look at our own roster of customers and our list of vendors, there is remarkable commonality. We look at first costs the same way a retailer would…[but] we look at changing the terms of sale to favor our control.”

I have tried to pull together an easy-to-understand diagram below, defining best value supply and how it varies from best-price and lowest total cost of ownership (TCO). (The latter being what most enterprises — and vendors — confuse with best value.) The chart also illustrates the technology approaches typically used at each stage and the pros and cons of each technique.

Click image to enlarge.

Best Value Comparison Chart.jpg

Best Price 

As the chart indicates, the traditional best-price approach is relatively straightforward and easy to implement. (My purchase price last year was X. This year, I paid X - 5%. Look at all the money I saved the company.)

The deficiencies of this approach are also clear: First, is the 5% discount I negotiated better or worse than the market price? Second, did my company (and the supplier) actually implement or achieve the full savings I negotiated? And, most importantly, what about all the other costs associated with doing business with that supplier (e.g., transportation and handling fees, landed costs, partial shipments, missed deliveries, poor quality, etc.)?

Online sourcing approaches, such as e-RFx and basic, price-only reverse auctions, enhanced the ability for supply and category managers to determine the best price. But at what cost?

TCO

Many enterprises are transitioning to a TCO approach, which incorporates all price and non-price factors (e.g., logistics and handling costs, landed costs, switching costs, set-up costs, transaction costs, etc.) into supplier negotiations and tracks price and contract compliance (e.g., quality, perfect order status, etc.) to ensure TCO goals are achieved. Widespread adoption of this TCO approach requires the use of advanced automation and negotiations, including spend analysis, multi-variant/total-cost-based auctions, and flexible bidding to allow suppliers to make alternative bundles and offers that differentiate on more than just price.

TCO is indeed a best-practice sourcing and supply management method. However, it is still a cost centric methodology focused on short-term gains that meet the year-over-year cost targets on which most supply management groups are measured. However, TCO overlooks the value contribution (e.g., innovation, long-term supply and cost assurance, parts standardization and reuse, marketing and branding, etc.) of supply.

Best Value

If supply management is to secure and sustain a seat at the executive table, it must shift its focus from cost reduction only to identify new ways to contribute and measure value creation for the business. Best value sourcing and supply management techniques measure TCO plus the cost and performance impact of improvements and deviance from long-range supplier and supply chain management plans. Most importantly, best value links supply management strategies to corporate goals, such as product innovation, market expansion, compliance and risk management, and, even, marketing and branding. And, unlike TCO, which tends to focus only on near-term results, best value defines and drives continuous improvements in supply performance and costs. In short, the negotiated agreement is just the starting point for delivering value and joint buyer-supplier competitive advantage.

Leading enterprises employing best value approaches use technologies like optimization, flexible bidding, and team-based or collaborative scoring during the sourcing process to ensure best total value and alignment with the business. They use supplier performance management technologies to scorecard suppliers and track improvement plans overtime. They also embrace alternative supply management approaches — such as demand or consumption management, co-sourcing or contract sharing, and buy-sell arrangements — that can continue to improve performance and remove waste and cost from the entire supply chain.

Obviously, embracing advanced best-value methodologies is not easy. (If it were, everyone would already be doing it.) Making the transition to best-value will require new processes, cross-functional alignment, measures and analytics, and technologies — not to mention a complete culture shift in how purchasing traditional operates and is viewed within the organization.

In the coming weeks, Supply Excellence will be examining best-value approaches and providing real-world examples of enterprises employing these techniques.

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6 responses so far ↓

  • 1 Michael Lamoureux // Mar 21, 2007 at 10:35 am

    For more on Best Value Sourcing, also known as Total Value Management, check out the eSourcing Wiki (www.esourcingwiki.com).

  • 2 Tim Minahan // Mar 21, 2007 at 11:31 am

    Thanks, Michael. That is a great site! Truly the Encyclopedia of supply management. (Although, like the old Encyclopedia subscriptions, I can’t wait until the rest of the collection is available.)

    I like the term Total Value Management. Even if it does introduce a new three-letter acronym (TVM). (The business world can’t get enough of those! :)

    But, seriously, Supply Excellence readers should check out the e-sourcing wiki. A wealth of valuable information from guys who know the discipline, like Michael and David Bush. They flesh out the best value concept in far more detail than in this post. And cite to lots of familiar research from the Aberdeen Group. (Although I’m surprised they don’t link to the Aberdeen reports cited. Isn’t that the power of the wiki…or the web for that matter?)

    Regardless, they definitely improve upon my proposed illustration of the differences between best-value and TCO. For example, Michael (or David, not sure who authored it) argue that there is a sourcing/supply approach between basic best price (what they call “Price per Unit (PPU)”) and TCO. This is TCA — total cost of acquisition, which they say includes “PPU, transportation costs, duties, tariffs, temporary storage costs, and any other external cost that is incurred from the time an order is placed to the time the product is received.” (I would argue that that is merely another phrase for TCO, but can see their point.)

    You can really get lost in the pages. There’s enough (and more insightful) info on supply management than most books I’ve read on the subject. I have bookmarked a bunch of stuff to go back and read. And like Wikipedia, you can even add a contribution to help define key supply terms. (Just don’t try to invent any more three-letter acronyms. Hopefully Wiki masters — if that’s a term — will put the kabash on that.)

    Michael, if you’re reading this, please give Supply Excellence readers a brief tutorial of how they can get actively “engaged” with the e-sourcing wiki site — rather than just being passive observers.

    Congrats on a job well done. A real service to the sector.

  • 3 Michael Lamoureux // Mar 21, 2007 at 4:35 pm

    Everyone:

    Here’s a brief tutorial on getting involved with the e-Sourcing Wiki.

    On the top right hand corner of the screen, there’s a register button next to the log-in button.

    This takes you to a page where you enter your name, company, selected user name, password, and e-mail. Enter your information and submit. You will then see a message “Thank you for registering! Your registration will be processed within 1 business day.”

    Once your registration has been processed, you will receive an e-mail verifying that your account is active.

    Once you have an account you can log in and start submitting new content as follows. Enter the wiki you want to contribute to. Above each section you’ll see an [edit] link. Clicking on the link will open the section up in an editor. Here you can submit new content to the wiki. New contributions will be monitored by moderators who will augment or correct any information added as required.

    The Guidelines/Help page gives you an overview of what you can do. It’s quite straightforward.

    Tim:

    To answer your first question, here’s a breakdown on the current and forthcoming series re: initial authorship. We’re hoping leaders, like you, will jump in and take them to the next level. [After all, as you'll see, my fingers are swollen.]

    David has assumed editor-in-chief for the time being. He’s also opted to farm out as much of the actual writing as possible (being busy enough with eSourcing Forum everyday) and then simply add in what ever is missing during the editing phase (to be as productive as possible).

    #1 Strategic e-Sourcing Best Practices
    1st draft: M. Lamoureux
    2nd draft: M. Beuc
    Editor: D. Bush

    #2 On-Demand / SaaS Application Platforms
    This one is mine, based on my weekend series last summer, which was partially based on a great CAPS publication.
    Editor: D. Bush

    #3 Spend Analysis & Opportunity Assessment
    Outline: M. Lamoureux
    1st Draft: E. Strovink
    2nd Draft: M. Beuc
    Editors: D. Bush & E. Strovink

    #5 Next Generation e-Auctions
    #6 Sourcing Decision Optimization
    1st Draft: M. Lamoureux
    2nd Draft: M. Beuc (in progress)
    Editor: D. Bush

    #4 e-RFX & Supplier Management
    #7 Contract Management & Compliance
    1st Draft: M. Lamoureux & M. Beuc (in progress)
    2nd Draft: ??
    Editor(s): D. Bush & ??

    #8 Sourcing Process Automation
    1st Draft: M. Beuc (in progress)
    2nd Draft: ???
    Editor(s): D. Bush & ??

    —

    #9 Cost Reduction and Avoidance
    Author: M. Lamoureux
    Editor: D. Bush (in progress)
    [ this will likely be next to post; expect in a week or two ]

    Future Entries #1 through #4
    partial first drafts;
    to be announced, and initial versions completed,
    after completion of the first 9

    This series installments will hit as soon as initial versions can be completed. (We’re perfectionists … we don’t want to launch anything that couldn’t stand alone as a white paper. We figure if it starts great, it will be easier to attract top talent to review and extend it. I believe David’s goal is at least one major wiki contribution a month, with a smaller contribution if time and resources are available.)

    As for your second, TVM was introduced at least a year ago. I’ve been promoting it since I started blogging last June. (See my Lead Time Optimization post, http://www.esourcingforum.com/?p=170, for example.) I’m sure it was used before then, but it certainly hadn’t caught on.

    As for the third, so focussed on the content that we all forgot to actually add the links to the referenced reports. It’ll get done … since the power of the wiki is that others can contribute.

  • 4 Supply Excellence » An Ad Worth Reading // Mar 22, 2007 at 8:14 am

    [...] In Search of Best Value March 22, 2007 An Ad Worth Reading by Tim Minahan at 8:14am [...]

  • 5 Supply Excellence » Are You Ready for Supply Management 2.0? // Mar 23, 2007 at 10:10 am

    [...] where sourcing decisions and subsequent supplier management strategies must be based not just on price or even total cost of ownership (TCO), but on overall network performance, risk management, and the value impact of supply on core business goals and differentiators. [...]

  • 6 dkfrobmsh wdiozxep // Jul 17, 2007 at 2:23 am

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