Risks can lurk in procurement contracts; take steps to mitigate them
PURCHASINGB2B MAGAZINE: JUNE 2011
Navigating a procurement contract can be like navigating a minefield. Some risks are obvious, others aren’t. The key is knowing what to look for and what your options are. How do you protect your company? Here’s an overview of the kinds of risks that crop up and how best to mitigate them.
Sole-source risk means there are no alternative sources for that product or service; in other words one supplier. If that supplier increases the cost, there’s an plant accident or the supplier shuts down, the buyer is potentially stuck.
Bill Michalopulos, general manager procurement for Canada Post, says his organization tries to avoid sole-source situations altogether, but if that’s not possible the organization does “an analysis and determines whether there’s any serious impact to the company from a revenue, cost or service standpoint.” But the biggest mitigation activity, he says, is ensuring the organization doesn’t put itself in a sole-source situation in the first place.
Try reverse engineering
Shawn Casemore, president of Owen Sound, Ontario-based Casemore & Co, has another approach to consider. He suggests sole-source situations don’t have to exist at all. “There’s a myth that if I have a sole source they’re the only company that can provide me with this product or service,” he says. Buyers could instead investigate reverse engineering. Keeping intellectual property rights in mind, there are companies out there that can take a finished product and “work it backwards” by taking it apart and figuring out how it was made. They can then reproduce a similar product.
Another way to work around sole sourcing, says Casemore, is to collaborate with the supplier either to have buffer inventory or to arrange to have a second supplier. The first supplier would be the main source for the product, owning all intellectual property rights to it, but a back-up supplier could help if production hurdles spring up.
Other risks include misunderstanding lead times for delivery. If a supplier says the expected or approximate delivery date is 16 weeks, it’s critical to look into all the factors that contribute to that date. Where did the date come from? How firm is it? Casemore says it’s really a matter of having an open dialogue with your supplier. Buyers shouldn’t have to chase their supplier when the date has passed only to hear that it’s going to be another few weeks.
Michalopulos says the contract with your ERP provider is another element to keep in mind. What happens once that contract is over and your organization has to switch to another provider? Implementing an ERP system once is tough enough, he says. “It’s a difficult one to mitigate in a lot of ways because the pain to change it is so significant.”
Another issue involves suppliers not updating their ERP systems to keep up with technological advances. Michalopulos says you have to assess how important that technology is to your organization. “If you engage technology to do something core, something critical, you have to keep that in the back of your mind: what’s going to happen in the future? What’s going to happen five years, six, seven or eight years from now?”
Another risk is not determining the full cost of ownership of a product or piece of equipment. Procurement professionals, says Casemore, must look at the whole lifecycle, right from planning to the end-of-life. “Often procurement professionals aren’t looking at the total cost of the lifecycle of that asset, they’re looking at what it costs to buy it and get it here, but they’re not looking at what it might cost to get rid of it down the road.” The risk lies in thinking they’ve got a great deal without accounting for the disposal costs later.
Also, guard against over-specifying or under-specifying products. If an organization over-specifies what it needs in a valve, for example, will that valve fit correctly in that organization’s system? Will it meet or exceed the same rigor? There are risks in how the specifications are set. If the wrong product arrives, an organization will have to buy it again, says Casemore.
Risks can be out of an organization’s control, like natural disasters and terrorism. But organizations can prepare by ensuring they have alternative suppliers that are geographically dispersed, says Michalopulos.
As organizations look for more ways to cut costs, the risks in procurement contracts have come to the forefront. While the responsibility to identify the risks lies mainly with procurement professionals, says Michalopulos, it’s often now shared across organizations.
“Procurement has a responsibility to expose the risks to the total organization, but it’s something the whole organization should be sensitive to,” says Michalopulos. “If you disrupt your supply chain, it can have huge negative implications for your revenue, your reputation and your service. Risk management now is a corporate issue and procurement plays a leading role in identifying and outlining mitigating factors one can take.” b2b