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Supply Markets Gone Wild

Five effective strategies for managing escalating input costs.

Fortnightly Magazine - May 2007


There is a major opportunity to offset commodity-price escalation with material specifications that are tied more closely to an OEM’s scale economies. Rather than shop your tailored material specifications, adopt material standards that comport with the industry. You can use a similar approach in supplemental labor markets, where utilities should pay closer attention to work methods prescribed by large contractors.

4. Establish Strategic Supplier Alliances

Today’s competitive dynamics call for a strategic-supplier relationship that goes beyond a “lowest price” relationship. Supply challenges of the past two years have been a rude awakening for companies maintaining a price-focused procurement strategy.

Both customers and suppliers are interested in such alliances. But these require capitalizing on product redesign and innovation. Sourcing organizations should focus more on value engineering and benchmarking activities in the sourcing process to identify product specification, design, and substitution opportunities.

Strategic supplier alliances can be applied equally to services spending, an area that has had less attention than materials/ products sourcing but that holds tremendous opportunities for value engineering. Tactics for unlocking this potential include creating a formal process for supplier development; involving suppliers as equal team members; engaging in “margin deconstruction” to fully understand service providers’ costs; and working with internal users to simplify their requirements. Many of these value engineering opportunities require changes on the utility side, so managers should be open to change where warranted.

5. Consider the Power of Outsourcing

Begin to develop the competencies needed to outsource. The U.S. market for business process outsourcing (BPO) is growing at 20 percent annually, and most providers in this area focus on providing transaction-intensive, back-office services in the areas of human resources, finance and accounting, supply chain/procurement, and administration.

The market is evolving toward integrated business process and technology service providers. Utilities generally lag behind other industries in evolving their business models to accommodate the benefits of outsourcing.

BPO has two main levers for improving costs and efficiencies—cost savings and efficiency gains. On the cost-savings side, labor arbitrage (the spread between the utility’s and outsource provider’s wage structure) contributes substantial, near-term savings. On the efficiency side, BPO providers tend to employ the latest automation technology, which they view as a way to grow revenues. As a result, cost containment here could be substantial without sacrificing service quality.

A New Game With New Tactics

Several trends will plague utility procurement teams for the foreseeable future. Global economic growth, particularly in China, India, and other developing nations, will continue over the long term. A combination of scarcity and environmental concerns will amplify price disruptions to fossil fuels, industrial metals, and power prices. Last, building out the infrastructure with an aging supply base that lacks depth will invoke further price escalation.

Each element of the energy utility infrastructure build-up will be affected by cost increases. Perhaps the biggest effect will be felt by the next generation of nuclear power-plant developers. The supply base needed in the nuclear sector suffers the additional burden of not having built a new plant in three decades. Capacity for these sophisticated units and the underlying supply base