Managing Procurement Risk

Friday, August 2nd, 2013

MANAGING PROCUREMENT RISK – SCIENCE OR ART?

Introduction

Who is ultimately accountable for managing procurement risk in your organisation? This is a question that should be asked by those at the top of the organisation. Based upon our experience, the answer will range from those Heads of Procurement who have systems and procedures in place to those who cannot produce any risk analysis that would withstand scrutiny. The most usual risk that receives attention is a strategic supplier who suddenly goes bankrupt. The vulnerabilities of the organisation, to this situation, will depend on the project, goods or services being delivered. In one client they had to deal with a situation (related to housing services – including emergency cover) where a strategic supplier went into administration early one afternoon. This led to furious ‘phone calls, seeking to locate a new supplier who could deal with that night’s emergency cover. There was no strategy in place to deal with this scenario. Another example is a private executive jet aircraft maintenance company seizing a jet aircraft because of late payment by the buying organisation. There is the somewhat dated payments terms adopted by some organisations, ‘Net Never’, where suppliers are expected to carry on providing goods even when payment is months behind schedule (we know this for sure!).

So, in short, potential risk abounds. It may never happen and that is the comfort drawn by the ill-informed. Of course, one catastrophic risk materialising, can cause severe reputational damage to the buying organisation. Let us take an extreme. It is a fact that in some sectors, the airlines are an example, where counterfeit goods will be supplied, accompanied by forged Certificates of Conformance. If this situation occurs on a safety critical item, the consequences are unthinkable. It then begs the question, “Where is this risk captured and who has the mitigation strategy?”

Is the issue of managing procurement risk swept under the carpet in your organisation? Who knows the answer?

Contractual Risk – The Specification

A good starting point for the uninitiated is the BAILII web site. This is the British and Irish Legal Information Institute. Here, you can access the judgments on cases that ended up in court, usually when arbitration or similar attempts to resolve the dispute have failed. The starting point of the logic is very simple. Who has the accountability in your organisation to ensure robust contracts are agreed? Let us assume that the answer is very clear – that is a dangerous assumption!

There is little doubt, in business, that a specification is vital. So far, so good you may say. Incredibly, there are contracts entered into when neither buyer nor seller has agreed what they require. In these situations the buyer is often at the mercy of the ‘technical’ specialist. If they are challenged by the buyer, the allegation will likely be made that buying is interfering and slowing matters down. In essence some specifications emerge after months (or years) of discussions, trials, tests and flawed reasoning. So how does anyone contract in this situation? They must agree a contract that has a ‘stop date’ when the specification will be finalised and agreed, otherwise the contract will be terminated. If this situation pertains, the liability for respective costs should be clearly set out. By the way, when the specification is agreed it is very useful to know who owns the intellectual property – but that is another story.

Contractual Risk – The Price

It has always been a fact of life that prior to entering into a contract a price is agreed, other than in circumstances where, for example, the specification is not finalised. For this exposition we will assume that the specification is finalised and agreed. What can go wrong now? Where are the pricing risks? There is unquestionably a risk when the buyer agrees the seller’s terms and conditions of contract. The seller who reserves the right to change the price at any time during the contract must find it hard to believe his luck when this is accepted by the buyer. Similarly, the public sector buyer who agrees a 10 year deal with the Retail Price Index as the automatic basis for an uplift, must have a party after contract signature. The fact that the price is escalating but the seller does not give their workers a wage increase for 3 years is inflating profit when wages are 60% of the selling price.

What risk exists when the buyer does not know the cost drivers of the supplier? The answer is considerable risk exists. Interrogating the cost drivers is a pre-requisite of good buying behaviour. Have you heard the adage that the seller will not release a cost breakdown because the detail is confidential? An old English word for this response is ‘Twaddle’. Within a project price it is almost inevitable that the seller will include a figure for ‘contingency’. What is this? One supplier explained 10% away as things that we cannot anticipate at the time of tendering. Really, so what happens if the contingency does not arise?  The answer is that the supplier makes 10% more profit than should have been the case.

If you would like to discuss this further or need any help in managing procurement related risks, please contact me r.gambell@brianfarrington.com or call on 01744 20698.

One Response


  1. Friday, August 2nd, 2013 at 12:41 pm

    Several of your questions will be addressed in our “Supply Chain Risk Management” study to be released in mid August.

    Joe