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Supply Markets Gone Wild

Five effective strategies for managing escalating input costs.

Fortnightly Magazine - May 2007

Make Sense?

For utility procurement teams facing a sellers’ market, a portfolio of change initiatives can prevent purchased goods and services from becoming the highest-growth cost center. The following five strategies should prove effective in coping with turbulent supply markets.

1. Build Out and Integrate Your Supply Market Intelligence Function

Have a plan to stay informed of volatile price movements, as a more interconnected global economy will amplify price-volatility curves. Procurement teams need to stay informed of changes affecting spending categories, and especially multi-year projects, on a weekly and monthly basis. Historically, such intelligence has been undervalued and often lacks the necessary expertise.

Develop cost models for specific spending categories and major projects that weights pricing trends of specific categories. Integrate this total-cost view with periodic cost reporting. Only with a total-cost model can one accurately predict the impact of a commodity price movement to spending categories. Only when asset managers pay attention to the impact of commodity price swings will this intelligence find a home. This last thought suggests the need to build stronger relationships and trust with asset managers.

2. Diversify the Supply Base to Foster Competition and Improve Security of Supply

Break down old biases surrounding the preferred supplier network. Most utilities have the opportunity to qualify new suppliers and help operations teams understand the value of new sources. This requires a more open-minded approach, as well as reducing the complexity of many supplier-qualification processes.

Take off-shoring seriously as well. Leading companies in many industries have developed and tailored global sourcing strategies. Airlines and manufacturing companies, for example, have made significant progress in identifying appropriate products to be sourced globally. They have developed the supporting supplier management infrastructure to manage off-shore projects successfully and are reaping the benefits.

Utilities have a significant opportunity to move domestically produced products to low-cost countries. Product specifications are precise and well written and can be produced easily. A few good candidates are any type of steel or metal items, components or sub-assemblies, poles, pole line hardware, and commodity plastics such as PVC pipe. (To be sure, managers also need to pay attention to “buy local” pressures in their regions.)

Although opportunities exist in other geographies, China is the primary source for international procurement. In addition to the short-term cost benefits, many companies are attracted to China because of the longer-term potential for a permanent structural reduction in supplier costs.

China offers tremendous advantages to an off-shoring program. But utilities should be careful in how they pursue off-shoring. They should develop core competencies in this area and slowly expand their footprint around a core set of purchase categories and developing markets that offer long-term upside.

3. Identify and Realize Specification Changes to Offset Escalation

Understand where changes to design specifications will bring supply-base leverage. The “design basis” for most energy utilities is steeped in tradition and generates tremendous passion among the engineering and design ranks. Yet in most cases, traditional design standards for everyday applications like substations, transmission lines, and distribution feeders are relatively static. This is particularly true for the underlying bill of