What caused the financial crisis?

The US $ 700 bailout package proposed by the US government is one of the most extensive government interventions in the financial markets since the great depression. The bailout plan is similar to the 1933 Home Owners' Loan Corporation of the post-depression era. Way back in 1933 it helped in stopping foreclosures and refinance defaulting mortgages , and increasing liquidity. That a similar proposal is being considered indicates the extent of damage caused to the banking and financial services systems all over the world.
But how did the banks and investment banks create this crisis? Let's cut through the financial jargon and understand in simple words how this problem was created in the first place. The root cause for the current crisis seems to be the excessive use of leverage.

Excessive leverage:

To take an example, a company with a net worth of US$ 25 billion borrowed 26 times its net worth and creates leveraged funds of US$ 650 billion to invest or lend them. When a small portion of the company's investments turns bad, as is the norm for the industry, the company's capital is under threat. To put things in perspective a 3.8 percent misjudgment in their books was enough to wipe out their shareholders' capital of $ US 25 billion.

Bad lending policies:

In 2005-07 the property markets were on a high growth path. The property prices kept increasing. A sense of complacency had set in the real estate markets . It was assumed that the residential property prices would keep increasing forever. Mortgage lenders relaxed lending standards. Billions of dollars of sub-prime loans were to given borrowers with the sketchiest credit histories on recommendations of mortgage brokers who were more interested in their commission. Loans were structured very innovatively. Some gave borrowers the ability to skip repayments and some had interest rates that rose over the life of the loan. Lenders were not worried about repayments as defaults if any, on loans, could be recouped from the property itself.
Contrary to this assumption, the property bubble burst leading to sharp depreciation in property prices. As loans were given to people who could not repay it in the best of time, mortgage repayments defaults kept increasing, triggering off a chain of events that led to the bankruptcies of the hallowed institutions of Wall Street.

Financial engineering:

Now you may ask how investment banks of the Wall Street who generally deal in investments in stocks, bonds and commodities have anything to do with mortgage loans. To understand this we move into the realms of financial engineering. Wall Street investment banks purchased the mortgages from the banks. This freed up banks' funds to lend more and gave the investment banks an underlying asset to create their financial magic.
Using these assets as collateral, they created derivative instruments and sold them to various institutional investors like hedge funds, pension funds, mutual funds and banks in all parts of the globe, including Europe and Asia. The instruments were to be redeemed as and when mortgage payments were received from borrowers.
The mortgages were categorised according to their quality. The good ones were pooled together under one derivative instrument. After being highly rated by credit rating agencies and insured from insurance companies these instruments were sold to institutional investors. The second quality ones got lower ratings, but nevertheless could be sold off with higher interest rates. The investment banks decided to keep the junk quality ones with themselves under separate companies called special purpose vehicles (SPVs) paying them the highest interest rates.
In all there was approximately US$ 1 trillion invested in these securities. Things were cruising along as long as property prices were on an upward trajectory . Once the tide turned the echo of defaults were heard far and wide. The value of mortgage-backed securities fell sharply. All institutional investors that had bought these highly-rated bonds in large volumes expecting a good rate of return now faced complete erosion of capital.

The jigsaw puzzle:

So, now, if we look at it as a giant jigsaw puzzle we have many independent pieces. One, a home owner who borrowed a loan; second , a mortgage lender who sold off his loans as income streams; third, an investment bank that purchased and re-engineered them; fourth, an insurer who through credit default swaps insured these debtbacked securities; and finally a bond holder who invested in these highlyrated instruments.
Now, due to defaults by homeowners all institutions up the chain are already bankrupt or facing bankruptcies.

Bailout to the rescue:

This is where the bailout plan is expected to solve the problem. The US government wants to buy mortgages and bonds from these near bankrupt companies with taxpayers' money. The plan as of now seems to be, after acquiring them at steep discounts, to hold them till maturity.
If all mortgages are paid back in full, the government can earn a handsome return on the taxpayers' money. This move will also help banks remove these illiquid assets from their balance sheets and free up the funds to be lent again, hopefully to good borrowers.
While experts seem cautiously optimistic that this bailout will solve the credit crisis to a certain extent, questions remain on whether it can prevent more failures of banks and Wall Street firms.

Bankrupt

Sorry for going offtrack, but could not help. From the day I started preparing for my B School Interviews in 2003, I was fascinated by the world of M&A's (Mergers & Acquisitions). There was a surge in M&A since 2003 an euphoria, what I call an urge to merge. I remember feeling elated and excited on reading the frenetic pace with which M&A activities were on, Sony buys MGM, AOL buys Time Warner. It made me proud to hear Ranbaxy buying a host of foreign drug companies and Tata buying Tetley and ofcourse the JLR (Jaguar Land Rover) deal was a crowning moment of India Inc. I would keep track of the different multi billion dollar deals, I would marvel at the way cash was produced on demand. As my interest in this area kept waxing, I started reading the different ways in which organizations would fund their acquisitions. It also brought me to a very interesting book by the name "Barbarians at the Gate" which detailed how RJR Nabisco was destroyed by a few greedy managers.
Today there is a lot of destruction in value; GM files for Bankruptcy, Lehman Brothers files for Bankruptcy, Meril lynch may be acquired. It is surprising that times change so fast. Lehman brothers, the favored destination for all the budding i bankers. The organization which only takes the best and the brightest of the Management graduates has failed to manage itself. Is it the subprime crisis, Is it an inability to weigh the risks? I am not sure, The euphoria has melted down and the only lesson that I take from this episode is to keep your feet firm on the ground as you try to reach for the stars, but do reach for the stars...

Negotiating by Phone

Negotiating by phone has both similarities and differences with negotiating in person.  Therefore, there are some special rules that you must apply when negotiating by phone.  These rules may sound too simple.  But don't dismiss them.  These little things can make a big difference in your negotiation success.

 

Don't Shortchange Your Preparation - Yes, negotiating by phone is different than negotiating in person.  But you must prepare just the same.  Know, in advance, what your target terms are; what you will say to persuade your supplier to agree to those terms; and how much you are willing to concede.  You must also be prepared for the questions your supplier counterpart may ask you.  Whether you stumble in your speech in person or stumble on the phone, you always weaken your negotiating position when you stumble.  So be prepared!

 

Always Initiate The Call - Negotiating successfully requires focus.  If you are caught off-guard by a supplier calling you, your focus will not be as strong.  If you pick up a ringing phone and there is a supplier representative on the other end and she wants to discuss terms, ask to call her back in five minutes.  Use that time to review what you prepared and then call the supplier.  Initiating the call gives you more control.

 

Turn Off Your Screens - In today's connected world, we expect ourselves to multi-task.  That's great.  But not during a negotiation.  Checking email during a negotiation will dull your focus and could result in your failure to object to terms that the supplier is introducing.  Eliminate the risk of such a distraction and just turn off your computer screen or Blackberry.  Your email will be waiting for you when the call is over.

 

Promptly Transcribe Your Notes - In-person negotiation discussions are easier to remember because you remember what you see, hear, and write.  In phone negotiations, you have one less sense for your memory to depend upon.  As you negotiate by phone, you probably scribble down notes about your conversation. They will make sense to you when you read them.  Until tomorrow. Type up your notes immediately after your call so that you can have a clear recollection of the negotiation outcome later.

Subprime Crisis

The last post promised a detailed discussion on the sub prime crisis. However, I felt that a discussion on the same is beyond the scope of this blog. While a personalised discussion is welcome, I have felt that the subprime crisis would be going to far from the world of sourcing. The treatment given in the last post, would I believe suffice for all the managers connected with sourcing. However, for those of you who would like to know more, Please click on the title. The hyperlink would redirect you to wikipedia where a detailed discussion is available. The treatment is comprehensive. In case it fails please click on the link below or copy paste the url in your web browser.

http://en.wikipedia.org/wiki/Subprime_Crisis

I have referred a diagram showing the causes, Effects and response put in a comprehensive manner by wikipedia here.

Secret behind the price hike of Caustic Soda

In my last post I promised to discuss the reasons behind the price increase of Caustic Soda & Soda Ash. Let me devote this post to the price hike of Caustic Soda. Caustic Soda is NaOH, Somebody suggested why don't we just take an aqueous solution of Common Salt (NaCl) & electrolyse it and produce NaOH. Ofcourse this seems to be a logical process. As I browsed through web pages I found that NaOH is actully produced in the way described above. However, the main product is not NaOH but Chlorine. Caustic Soda is a byproduct of the chlor-alkali process. Therefore, the supply of Caustic soda is dependent on the demand of Chlorine.
The price of Caustic Soda is supposed (actually)to have gone up due to the non availability of the product. It is the supply- demand game that is playing out. If the supply of Caustic Soda has gone down, it is assumed that the demand of chlorine must have gone down. The demand of chlorine is supposed to have gone down due to the subprime crisis.
The obvious question is, What is the subprime crisis ? The answer to this is beyond the scope of this post. However, we will be discussing the same in the next post. For now briefly; The crisis is evolved due to Mr. Bush exhorting the American public to spend their way out of the recession of 2002. Banks started giving loans, housing loans to the general public who carried a credit risk i.e those who may not be able to repay the loan due to unstable incomes, low income or a host of other factors. These were the subprime guys. When the real estate prices crashed due to oversupply of houses, these people found that the net repayment was higher than the market rate of the houses. Therefore there was a mass default of the loans. Meanwhile the banks had bundled the subprime loans and started selling the same to different financial institutions, as instruments. The defaults led to a revaluation of the price of the instruments which pulled the value of the instruments down. (Keep watching for the next post for a detailed discussion). The cascading effect was both a drop in demand for houses or new projects as well as huge losses creeping into the books of the financial institutions.
Going back to the second paragraph, Chlorine produced from the chlor alkali process described is primarily used in the manufacture of polyvinyl chloride resin which is again primarily used by the housing industry. With demand for housing falling, consequently demand for polyvinyl chloride resin fell and consequently the demand for chlorine. This led to a drop in the operating rates of the chlor alkali plants leading to a drop in the supply of caustic soda and with it the hike in prices of caustic soda. Phew... that was one hell of a chain reaction...

A bleak picture turning rosy ?

Companies are raising prices at break neck pace. The rising input costs has painted a gloomy scenario for the procurement function. The industry is faced with two dilemmas:

• Either it increases the prices of its products in response to the increase in key input commodity prices & thereby risk losing the market.
• Continue to hold on the price increases and risk diminishing margins or possibly bleed.

Also a degrowing market has not helped the cause. The problem is compounded in the Indian pharmaceutical industry faced with a triple whammy.

1) With the Olympics due in China, China would want to present itself as a country which is conscious of the environment in which it lives. Therefore, all the chemical firms (supplying intermediates) that were flouting the global environmental norms are being forced shut. This has led to a huge supply crunch. The output has dropped to 40% of the previous year, leading to
unprecedented hike in input costs.

2) The crude story is well documented and would not need much elaboration. However the key reasons identified for the increase in crude price are: (order depends on where you live & who you are)

a) Falling dollar (due to sub prime crisis)

b) US Iran standoff

c) Increasing consumption of oil by third world countries

d) No increase in production

e) Excess Speculation

f) Rising costs of oil exploration & development

3) Key pharmaceutical product prices are controlled by the government (whoever talked of liberalization). Prices of essential drugs are fixed by the government and are revised only through a lengthy, time consuming process. To quote an example, Ibuprofen is considered an essential drug and the government fixes the price of the finished product marketerd by the companies. Ibuprofen was hovering at around Rs 400/- when the government last fixed the price (about six months back) and today the same is hovering at around Rs 500+. To make matters worse the cost of the input Ibuprofen represents 90% of the cost of the finished product, & 65% of the Average selling price. Therefore if the price of the key active pharmaceutical ingredient rises by 25%, the pharma company starts bleeding. This is the reason why many of the pharma products are going of the shelf.

However, all is not lost. China is expected to revive production in a short while and all the pharmaceutical organizations are waiting with bated breath for the olympics to be completed & factories to resume operations. Crude is expected to soften on the back of anticipated production from Brazil, Canada & Central Asia and also due to softening of demand. The government is expected to revise the pricing norms in a shortwhile based on the stable conditions expected to arrive in a short while.

Now you maybe wondering the reason why I have not mentioned the ever so ubiquitous inflation as one of the three reasons. Well inflation is an effect of these three, atleast in the pharma industry. There are other minor factors too like the rise in the prices of Soda ash & Caustic soda. I will be discussing the same in another post. Till then keep your fingers crossed, pray for the early completion of the olympics, discovery of more oil fields and revival of the global economy.

Europe Catches e Sourcing Fever

This is a post from the European Procurement Leaders Network which has been reproduced here for the viewers of this blog.

Tim Minahan of Ariba

Compared to North American firms, European procurement organisations have been reluctant to embrace online sourcing approaches. Their long-time reticence has stemmed from resistance to e-sourcing methods both internally and from suppliers, as well as from a general misunderstanding that e-sourcing = e-auctions. (It doesn’t.)
Yet, private conversations and public presentations at Ariba LIVE Brussels offered hope that e-sourcing (including online auctions) is fast becoming standard operating procedure on the Continent.
Over a dinner and bottle (or two) of fine French wine, a procurement executive from a European aerospace manufacturer, told me that he directs his team to use e-sourcing for every sourcing project. And he prefers that they run a reverse auction. “We are of the mindset that you can auction anything. We’ve auctioned everything from IT to legal services. I refuse to accept that something can’t be put out to bid.”
His gusto was matched by the head of sourcing for a European oil and gas company: “We now align [buyer’s] incentives with how much of their spending is sourced online. We view e-sourcing as the sourcing process, not a subset of it.”
Listening to Telefonica CPO Juan Carlos Montejano Dominguez deliver the Ariba LIVE Brussels keynote the following morning, it was easy to see why European procurement leaders have caught e-sourcing fever.
Over the past year, Telefonica ran more than 35,000 e-sourcing projects for nearly €17 billion in goods and services — a more than 1,500% volume increase since 2003, the first full year of the e-sourcing program. And the telecommunications giant is far from finished. Dominguez is pressing his team to hit a run rate of 70,000 e-sourcing projects per year — a third of which will involve e-auctions.
Why is Telefonica so bullish on e-sourcing? Simple: results. As the below chart clearly indicates, Telefonica has yielded far greater returns from its e-sourcing than offline sourcing projects. And returns from e-auctions are even better.

Dominguez reported that e-sourcing has yielded considerable benefits beyond negotiated savings. Since launching its e-sourcing program five years ago, Telefonica has:

Cut sourcing cycle times in half.

Reduced management cost per awarded amount by more than 27%

Increased the amount of spend managed per FTE by more than 85%.

In addition to these benefits, Dominguez said e-sourcing has actually improved supplier relationships. “e-Sourcing has introduced a new level of integrity and transparency into the process,” said Dominguez. “It increases competition and objectivity in award decisions.”
To back up his assertion, Dominguez shared the results of a recent survey of Telefonica suppliers. Some key findings:
77.3% of suppliers felt e-sourcing “promotes competition and equality of opportunities”
80% said e-sourcing “increases transparency of the purchasing process”
And, more than 70% of suppliers reported that “e-auctions are a transparent method of contraction and they guarantee equal opportunities.”
Feedback and results like these underlie why e-sourcing is finally being widely adopted across Europe.

Strategic Sourcing - Overused and Little understood

The ‘S’ word is getting a real hammering these days, often wantonly, often inappropriately, and often - just plain too often. If people thought more clearly about its real definition, then we would all be better off – so here is a view.
Most people sprinkle ‘strategic’ around in the context of having some sort of plan – ie ‘We have done a strategic category review’. This is not really a good use of the word – it is simply using a fancy word when ‘plan’ would do just fine. Of course it should be well thought through, be linked to the business needs, and have a longer term perspective – that doesn’t really qualify for the strategic title.
Secondly it is used to as a plea to become more involved – ‘we need to do more strategic purchasing’. Most of the time this just means that buyers don’t really get involved early enough, and want to be more a part of the business. Fair call – and not strategic.
There is only one clear definition of a strategic action:
Deferred Pleasure.
A strategic decision is one that, on the face of it, only makes sense in the longer term. If in military terms a location is deemed to be strategic, that means you should put disproportionate effort into defending or gaining it. The same is true in purchasing. You could take a position on a category, or with a supplier, where you are taking the risk that in the longer term you will be better off. Committing to 100% supply ( or indeed deliberately taking a supplier off your supply list ), taking a long term price fix and investing in joint development are all examples of strategic purchasing.
The interesting challenge lies for the wider business – just how many business unit managers would thank you for saying ‘I know you are paying more for this than you have to right now – but its strategic!’
We may want purchasing to be more strategic, and if we really mean it – are we or others actually ready for it yet?

Success factors for Professional Purchasing

High performance purchasing with long-term strategic orientation is a key factor for successful international competition. Therefore, purchasing is one of the most important issues in a company – material costs are the largest cost block in an industrial company. Due to this situation, efficient cooperation with suppliers is becoming increasingly important.
An important success factor for professional purchasing is achieving transparency, especially regarding company-wide purchasing activities, purchasing volumes, frame contracts as well as detailed information about current and potential suppliers. A company can attain this comprehensive view through integrated supplier qualification, contract management and spend analysis.
An active and targeted supplier management is the prerequisite for strategic purchasing. Cross-functional supplier rating identifies supplier strengths and weaknesses. Suppliers are categorized according to their performance and strategic significance based on a substantiated and objective supplier classification. This is the basis for targeted and structured supplier development including measures controlling. During this process, supplier goals are set, deadlines and responsibilities defined, sustainable optimization measures implemented and development progress monitored.
Experience indicates that the individual components must interact with each other in order to provide consistent process support and that maximum benefit can only be achieved through the consolidation of the corresponding information obtained.

Internet Transformed in a blink of an eye

We here at Sourcing Diaries like to think we're not backwards in coming forward when it comes to embracing the power of the Internet.
It would take a brave man to deny that the World Wide Web has transformed modern-day business, so you can imagine the excitement around these parts when talk of ‘the grid’ replacing the Internet, surfaced earlier this week.
The ‘grid’ is nothing new – a cursory google search reveals that a press release trumpeting it’s future was circulated in 2002, but recent developments in Switzerland have caused understandable ripples from Geneva to the Galapagos Islands.
Scientists in Switzerland claim the new ‘grid’ is 10,000 (yes, that’s ten thousand) times quicker than your average broadband connection.
The pioneer of the system, hardly surprisingly, is Cern – the particle physics centre that created the Internet – and it claims that grid will soon offer lighting fast capability for tasks such as high-definition video telephony (all for the price of a local call), and the downloading and sending of sophisticated images. All performed in the blink of an eye, and certainly before you can say ‘Shaan’.
David Britton, professor of physics at Glasgow University and a leading figure in the grid project, believes grid technology will not just revolutionise the way businesses do business but could also change society.
“With this kind of computing power, future generations will have the ability to collaborate and communicate in ways older people like me cannot even imagine,” he said.
Now that, is progress.

CSR and Procurement

Corporate Social Responsibility (CSR) is a concept with growing currency across the globe. It involves looking at how companies take account of social and environmental factors and how these can impact on their reputation among consumers and in the business world.
The involvement of procurement and supply management professionals in CSR policies is increasingly crucial. Sourcing from low-cost countries, for example, is an area fraught with dangers for the procurement function and the business as a whole. Senior procurement managers are ideally placed to input expert knowledge and experience in discussions of low-cost country sourcing in a way that can help reduce the risk of extremely damaging publicity or dealing with costly legal challenges.
It is therefore imperative for procurement and supply chain departments to build constructive relationships with key stakeholders while increasing business transparency and good governance. In this way they can play a pivotal role in shaping the business in a sustainable and competitive way, making sure the highest ethical standards are followed.
The mentality of "out of sight, out of mind" outsourcing is a serious mistake.

Oil rising up agenda as price rise shows no sign of slowing

If oil wasn’t topping procurement’s agenda at the turn of the year, it certainly is now. With the cost of crude rise near to a potentially ruinous $140-a-barrel.
Hardly music to procurement’s ears given that a recent CIBC World Markets Report claimed that once oil hit $120 a barrel, “Every 10% increase in trip distances translates to a 4.5% increase in transportation costs.”
Busch uses the example of the cost of shipping a container from Shanghai to the eastern seaboard of the US having risen 250 per cent since 2000 (when oil prices were a relatively benign $20-a-barrel).
Clearly the latest price hikes are going to put more pressure on those organisations that lean heavily on global sourcing. Any further rises and they may start to ask, if they haven’t already, if the strategy is really delivering the results it once did.

Why e Sourcing is good for suppliers

This post is from the Procurement Leaders network, It tries to dispel a few myths people hold on the e Sourcing tool.

Myth #1: e-Sourcing is all about lowering prices. False. Thanks to tightening supply markets and maturing sourcing methods (and e-sourcing functionality), price-only negotiations have gone the way of Member’s Only jackets. Advanced auctioning capabilities enable buyers to evaluate suppliers on a myriad of price and non-price factors, such as lead-time, delivery, quality, and payment terms. Nearly all e-sourcing users engage in multi-threaded negotiations (e.g., e-RFI-to-e-RFP-to-auction), enabling qualification and evaluation on all attributes of a supplier’s capabilities and costs. And many optimization-based sourcing tools allow suppliers to offer alternative bundles or bids that boost their profit margins and further differentiate their offerings.
Myth #2: e-Sourcing is unfair to suppliers. Untrue. In most cases e-sourcing introduces greater integrity into the sourcing process than existed in the offline mode. e-Sourcing mandates that buyers clearly articulate their selection criteria and award decision framework to all participating suppliers. Suppliers go into a negotiation full knowing how they will be judged and how the award decision will be made. Any clarifying questions asked by suppliers and corresponding answers from the buyer are available for all suppliers to see, further leveling the playing field. This was best summarized by a VP of Sourcing at Cadbury Schweppes “We emphasize fairness and open disclosure on both sides of the sourcing process. We have shut down ‘backdoors’ for internal stakeholders and suppliers.”
Myth #3: e-Sourcing is unfair to incumbents. Nope. Competitive incumbents are in a better position to be exposed to more business volume and new business opportunities, particularly considering that any strategic sourcing initiative goes hand in hand with a supply base rationalization effort. Better e-Sourcing tools also enable the ability for users to incorporate “transformational” elements that give “credits” (in the form of switching costs or innovation credits) to good performing incuments. As a result, incumbents don’t need to be the lowest price bidder in order to win the business. Consider the approach taken by Eastman Kodak: “We sat down with incumbents to explain why we were [using e-auctions] and prepare them with the right strategy and techniques to competitively participate in the event.”
Myth #4: e-Sourcing makes it difficult to win new business. On the contrary, e-sourcing dramatically shrinks sourcing cycles. These efficiencies alone enable buyers to negotiate more spend volumes, across more spend categories, with more suppliers. As noted in the previous example, qualified incumbents in good performance are in a position to expand existing business and be exposed to new business opportunities. One large industrial manufacturing used its e-sourcing strategy to cut the number of MRO suppliers from nearly 2,000 to just 20. Incumbents retaining the business are doing 4X to 10X the volumes than in the past, and they’ve added new, more profitable revenue streams, such as integrated supply relationships.
Myth #5: e-Sourcing lengthens the sales cycle. There is ample evidence that e-sourcing shortens sourcing and, hence, sales cycles. And as an old boss of mine would say, “In a sales cycle, getting to no fast, can be as valuable as getting to yes.” His point was getting to “no” enables you to focus your salesforce on the opportunities they can win.
Myth #6: e-Sourcing burdens suppliers with new cost, technology, and resource requirements. Wrong again. There is compelling evidence that e-sourcing also reduces overall SG&A costs. A recent study from the University of North Texas found: “A supplier can reduce its cost of sales (salesperson commissions, advertising, etc.) using reverse auctions.”
Myth #7: e-Sourcing eliminates buyer-supplier relationships. I recently asked a supply management executive at a major life sciences company how he was able to drive such aggressive use of reverse auctions. His response, “I tell suppliers, ‘If you believe your customer relationship is all about negotiating, then you don’t have a relationship.’” This isn’t just rhetoric. Many companies have begun partnering with suppliers to remove cost from the entire supply chain. New multi-tier sourcing, co-sourcing, and buy-sell approaches are being embraced by a wide range of enterprises (particularly in the aerospace, automotive, and high-tech sectors) looking to gain better visibility into costs and risks inherent in the sub-tier supply and to aggregate spend volumes and remove costs from the total supply chain.

Product/ TPM/RM-PM/ Vendor Coding systems

These four codes are the pillars on which the entire materials spend analysis rests. In this section we explore the logic behind each of the codes & how they help the material spend analysis file as well as the product cost sheets work. These would also aid us in further expanding the analytics and get us to perform various permutations & combinations.

The codes have been developed with a view to accommodate all the business processes of the organization and it is the developer’s vision that the codes would be used universally.

To begin with we analyze the product codes that have been developed:

Product Code:

The products marketed by us have been given a 12-digit code. To illustrate the working of the codes we explain by taking an example.

Serotin AST 100ml Physician Sample
3VST2010100P


First Digit: The first digit of any product code represents the marketing division that handles the product. This helps the spend analytic software to perform analytics for each division. Also it helps segregate products based on the division that is concerned. In this case we have provided the following nomenclature:

1 – ABC
2 – DEF
3 – HIJ
4 – KLM

There is provision for expansion of Divisions so that any new segregation can be done easily.

For e.g.: In this case Serotin AST 100 ml Physician sample is marketed by HIJ hence the first digit is ‘3’.

Second Digit: The second digit of any product code represents the therapy area that the product handles. The same benefits as segregating the product on the basis of the marketing division helps us by segregating on the basis of the therapy area. The software can analyze the portfolio of each therapy area therefore providing essential information on the particular therapy area. In this case we have used the first digit of the therapy area to be represented in the code.

G – Gastroenterology
N – Neuroscience
P – Pain Management
M – Metabolics
U – Urology
V – Vitamins
A – Antibiotics
H – Hospital Care
O - Others

For e.g.: In this case Serotin AST 100ml Physician sample belongs to the therapy area Vitamins, hence the second digit is ‘V’.

Third & Fourth Digits: The third and fourth digits are the first and last digits of the brand whose code has been defined. These are only provided to enable the human mind to identify the product.

For e.g.: In this case Serotin AST 100ml Physician sample has the first and last digits of the brand name as ‘S’ & ‘T’. Therefore the code contains ‘ST’ as the third & fourth digits. Similarly Glaco Total is ‘GL’ and Glaco OD is ‘GD’.

Fifth Digit: The fifth digit represents the type of packing that the product has undergone. This is one digit, which would need further refinement. As of now the nomenclature stands as follows.

1 – Tablets/ Capsules in blister/ PVC/PVDC or foil
2 – Bottles whether they contain capsules or liquid.
3 – Injections/ Vials

The above coding system allows users to identify the kind of primary packing and develop appropriate distribution/ Packing strategies.

For e.g.: In this case Serotin AST 100ml Physician sample is packed in bottles in liquid form therefore the code contains the fifth digit as ‘2’

Sixth, Seventh, Eighth Digits: The sixth, seventh, eighth digits represent the potency of the drug. This helps users differentiate between two drugs with the same brand name and with the same packing. A classic case in question would be Blickan 200, Blickan 400 & Blickan 600. These are only differentiated by the potency of the drug involved.

In this case, 10ml of Serotin is the recommended size of dose. Therefore the sixth, seventh, eighth digits are ‘010’ respectively.

Ninth, Tenth, Eleventh Digits: The ninth, tenth, eleventh digits represent the pack size of the drugs. They help the user identify the primary pack size. A classic example would be Blickan 200 9’s pack and Blickan 200 15’s pack. The last three digits help in differentiating each other.

For e.g.: In this case Serotin AST 100ml Physician sample is packed in bottles of 100ml each. Therefore the ninth, tenth, eleventh digits are ‘100’

Twelfth Digit: The twelfth digit if left blank represents a sale pack and if denoted by ‘P’ represents the physician sample. The digit has been provided only to distinguish between a sale pack and a physician sample pack.

The product codes may be expanded to include other details as well. In a few exceptions, where the names of the products are very similar the third and fourth digits have been appended with one more small case digit. This differentiates between two similar products with similar spellings and similar attributes.

Third Party Manufacturer Codes (TPM Codes):

The TPM codes are fairly simple and the following is the nomenclature. To explain the coding system we take three examples.


A110 – AKMA
A120 – ACOM
B400 – BLODIA.


First Digit: The first digit of any TPM code is the first letter of the TPM name.

For e.g.: The first digit of Akma and Acom is ‘A’. Therefore the first digit ‘A’ represents both the codes. The first digit of Blodia is ‘B’ hence represented by ‘B’.

Second Digit: The second digit of any TPM code is the CST applicable when the product is billed from that location.

For e.g.: The CST applicable when the products are billed from Akma or Acom is 1% therefore the code given is ‘1’.

Third Digit: The third digit is the serial numbers to differentiate between two TPM’s with in the same location and with the same starting letters. A classic example is Akma & Acom. Since both begin with the same letter the serial no 1 & 2 have been used to differentiate the two.

Scope of Expansion:

The fourth digit has been left blank on purpose. The same may be used to denote a TPM located in the excise free zone Vis a Vis a TPM located in the non-excise free zone. Alternatively any other important attribute may be used to signify the fourth digit.

RM/PM Code:

The RM/PM code developed is in a very rudimentary stage as the different attributes of the RM/PM need to be understood before defining the codes. Nevertheless it allows for functioning and currently the following have been incorporated in the codes.

The first 2000 digits 0000 to 2000 represent the Active Pharmaceutical Ingredient that go into the product. The code for each of the API is given alphabetically. Based upon further important criteria, codes may be modified.

The digits from 2001 to 5999 represent excipients, which aid in binding, sweetening and other properties. The structure followed to code the excipients is as given below.

2001 – 2300: These are the Binders. The unique codes for each of the product are given alphabetically.
2301 – 2800: These are the Coatings. The unique codes for each of the product are given alphabetically.
2801 – 3000: These are the Glidants. The unique codes for each of the product are given alphabetically.
3001 – 3300: These are the Fillers. The unique codes for each of the product are given alphabetically.
3301 – 3400: These are the Disintegrants. The unique codes for each of the product are given alphabetically.
3401 – 3600: These are the Lubricants. The unique codes for each of the product are given alphabetically.
3601 – 3900: These are the Preservatives. The unique codes for each of the product are given alphabetically.
3901 – 4800: These are the Flavors & Colors. The unique codes for each of the product are given alphabetically.
4801 – 5000: These are the Sweetners. The unique codes for each of the product are given alphabetically.
5001-5999: These have been left blank intentionally to accommodate for any expansion in the excipient category/ excipients.

The digits from 6000 to 9999 represent the Packing material that is used to pack the product. The different kinds of packing used are Primary, Secondary & Tertiary packing.

The primary packing material is further subdivided into bottles, foils etc. The coding system is as given hereunder.

6000 – 7499: Primary packing material. The primary packing is further subdivided as follows.
6000 – 6099: These are the Plastic containers & Caps. The unique codes for each of the product are given alphabetically.
6100 – 6350: These are bottles. The unique codes for each of the product are given alphabetically.
6360 – 6599: These are the caps. The unique codes for each of the product are given alphabetically.
6600 – 6699: These are PVC foils. The unique codes for each of the product are given alphabetically.
6700 – 6799: These are PVDC foils. The unique codes for each of the product are given alphabetically.
6850 – 7139: These are Aluminum foils. The unique codes for each of the product are given alphabetically.
7140 – 7249: These are Blister foils. The unique codes for each of the product are given alphabetically.
7250 – 7349: These are Glassine foils. The unique codes for each of the product are given alphabetically.
7350 – 7399: These are cups. The unique codes for each of the product are given alphabetically.
7400 – 7499: These are miscellaneous primary packing items. The unique codes for each of the product are given alphabetically.

7500 – 7949: Secondary packing material. The secondary packing is further subdivided as follows.

7500 – 7849: These are cartons. The unique codes for each of the product are given alphabetically.
7850 – 7949: These are Catch Covers. The unique codes for each of the product are given alphabetically.

7850 – 9999: Tertiary packing material. The tertiary packing is further subdivided as follows.

7950 – 7959: These are Hologram labels. The unique codes for each of the product are given alphabetically.
7960 – 8299: These are Labels. The unique codes for each of the product are given alphabetically.
8300 – 8789: These are DFC’s. The unique codes for each of the product are given alphabetically.
8790 – 8839: These are Shippers. The unique codes for each of the product are given alphabetically.
8840 – 8999: These are miscellaneous items provided for expansion of scope of products. The unique codes for each of the product are given alphabetically.
9000 – 9199: These are Gum pastes/ adhesives/ BOPP Tapes. The unique codes for each of the product are given alphabetically.
9200 – 9300: These are labels. The unique codes for each of the product are given alphabetically.
9300 – 9999: These are blank codes provided for expansion of scope of products. The unique codes for each of the product are given alphabetically.

Marketing & Admin Spend Analytic

The next major category of spend identified is the Marketing and Administration spend. I would like to reiterate that the Total spend analytic tool has limited value here as it does not enable the level of drill down that we would be interested in disabling us from strategizing on the supplier networks. As I have mentioned previously this tool was made possible because we have a centralized purchasing system. It can also be made possible if data of different spends is available in the organization. Of course that would require us to modify and suit the tool based upon our requirements.
In order to do this we took a dump of all the Purchase Orders that had been issued in the previous year. Lack of an IT system and manual filing of the PO’s made the job extremely tough. We had to hire data operators to get the 1500 odd PO’s punched in the system. To get over this problem in the coming year we developed an Online requisition system, more on the same in the online requisition system. Presently we will be discussing about this tool.
This file is again made up of three sheets.

• Data Sheet
• Analytic Sheet
• Summary Sheet

The data sheet contains all the POs issued in the preceding financial year, classified by the date, Item description, Item Category, Department, Division, Supplier, Spend. The data sheet is only a dump of the existing purchase orders.

Depending on the combination of requirements chosen the tool would throw up the spend on each suppliers and each department. The three tools Total Spend Analytic, Material Spend Analytic and Marketing & Admin Spend Analytic would help us in our further endeavors to identify areas to focus & cut costs.

Total Spend Analytic

The total spend analytic was made by taking a dump of the general ledger for the preceding financial year. For a spend of 5.6 bn INR the system dump lead to a file running to 80MB. This looked like a dead end as Microsoft Excel or for that matter any other spreadsheet software is limited by the number of rows that it can handle. We therefore had to find an innovative way to extract only the relevant data and get it in a presentable format. To get over this we first had to identify what was it that we needed? All we needed from the general ledger is the department wise division wise category wise spend. The date of spend would also have been a valuable data entry to track the movement of spend. However, the resources in place were limited and therefore we developed a C program which would sum up each category of spend over the entire year. This way though we would not be able to track the movement of the spend over a time frame. We still had a consolidated spend of the entire year for each category in a much more manageable size. A point worth noting here is that we had used the C program not because it offered us some advantages over any other programming language but because I as a Mechanical Engineer had learnt only the basics of C about 8 years back. I was conversant with only this language and therefore we used the same. I’am sure that there maybe better ways of doing the same and also having the spend movement tracking. (Please check footnote to find why spend tracking is essential)

The 80 MB file broken into a text file of 1.7 MB was manageable. This sheet went in as the data sheet classified in the heads shown below:

Ø Division
Ø Department
Ø Description of Spend
Ø Level of Influence
Ø Actual Spend

While the Division, Department, Description of Spend & Actual Spend was had from the dump itself the level of influence we can have on each of the spends was input manually by sorting the spend on the basis of the description. In order to throw up the actual spends for the preceding year, under different combinations of Department, Division, Description and Level of Influence we took the aid of macros and pivot tables. To clarify the working of the spreadsheet I would quote an example.

Selecting the marketing division only would allow me to evaluate the total spend of the different marketing departments under different categories like POP Print, POP Gift, Events etc… Selecting a particular department under marketing would give me the spend of the same department under various categories like POP Print & Gift etc. Selecting the category of spend only would give the spend of the entire organization and also under different departments. Thus enabling us to have a macro picture of the spends.
This tool would allow anybody to identify spends across any of the heads under any combination desired. While this tool enabled us to identify and classify the spends we needed a further drill down. To enable further drill down we developed two more tools which I have mentioned above and will be describing below.

Spend Analysis

This is the starting point of any strategic sourcing job. A spend analytic identifies the spend into major categories and allows for classification of the spend into major categories. This leads to further investigation of the spend and to strategize based upon the importance of the spend. An important point to realize here is that the strategic importance of a spend is not just related to the price or the quantum of spend, but also to the risks associated with the spend. Therefore, the spend analytic only does a part of the job in determining the quantum of spend and classifying the spend. Strategizing the spend is another ball game that will be dealt in a short while.

Here also there are a number of spend analytic tools to aid us. When you google for spend analysis you will find a number of softwares on the right handside. However, I have never used any of these, therefore I will not be able to describe the same to you neither will I be able to recommend you any. I have however, used spreadsheets for the same and they are very effective. Here I will talk about three tools that I have been able to develop. The first two tools developed are not specific to any organization and may be developed anywhere. However, the third can be developed with ease when you have a central purchase department or data of different departments are available easily.

Ø Total Spend Analytic
Ø Material spend analytic
Ø Marketing & Admin Spend analytic.

Supplier Databases

While a great many softwares are available in the market. The essential thing to remember is that atleast the basics of a company and its capabilities should be captured. These include:

Ø Supplier Name
Ø Supplier Address
Ø Product portfolio
Ø Client portfolio
Ø Financial muscle
Ø Manpower capabilities
Ø Technical capabilities
Ø Quality certifications
Ø Performance measures (More on performance measures later)

The software needs to be dynamic enough not only to capture the details but also allow for enrichment. While a periodic review of the databases seems to be ideal, my experience has indicated that it is prone to mistakes and at times lethargy creeps in and one has to build up a command and control structure. The databases lose relevance in a short while and become practically useless.

In this regard I have felt that we need to classify our spends based upon strategic importance. Once these have been classified, we are left with a relatively small number of suppliers and strategic spends to manage. Also because of the nature of spend being of strategic importance the buyer tends to have a close relationship with the supplier, therefore the buyer can & does manage the database more effectively. Also limited access maybe given to the supplier who can update his portfolio as visible in the customers database. I have worked in one of the largest automobile company in India and also in one of the largest pharma MNC’s of the world. While I have not been able really incorporate the kind of supplier database that I speak of, I believe that this is a reality. We have been maintaining this database in Excel & Excel is not really well suited for this job. Incase any of you can come up with a better solution I would appreciate the same.

Strategic Sourcing an Introduction

Strategic Sourcing is the institutional procurement process that tries to continuously improve upon the existing sourcing processes in order to minimize the sourcing risk and costs.

The steps followed in any strategic sourcing process are:

• Assessment of the current spend.
• Assesment of the risks & the costs associated with each spend.
• Identification of current supply base.
• Developing an appropriate sourcing strategy based on Supplier, Cost & Risks.
• Assessing the supply market.
• Negotiating with potential suppliers.
• Institutionalizing the revised supply structure.
• Track results & restart the process.
  
  

A number of tools are used to help the strategic sourcing process. The development of powerful soft wares in the current decade has enabled simulation under different supply conditions. A brief description of the tools and how they aid in the above-mentioned steps is described below.

Strategic Sourcing as defined by the procurement leaders network stands as follows:

"Procurement is defining its own culture: processes have had to become sharper and faster to be able to deliver in ever-tighter competitive environments. Sourcing no longer equates to instant cost gratification, but is now defined as a strategic component used to drive maximum competitive advantage.

Strategic sourcing is itself a benchmark. It relates to getting the best products and services at the best value. It is designed to segment external spend and ensure that procurement resources are focused on the most important categories. What sets strategic sourcing apart is its continuous attention to improving and re-evaluating the purchasing activities of a company, thus enabling organisations to adapt to changing market forces."

Systematic strategic sourcing was initiated by General Motors in the 1980s and soon became a common business tool. Many companies worldwide reviewed their purchasing activities and initiated strategic sourcing programmes in response to the rise of China as a global manufacturing hub after its accession to the World Trade Organization in 2001.