Cost Management and Procurement: Forgotten assets.
Constantin T. Gurdgiev Department of Economics, Trinity College, Dublin.1
Introduction The current economic environment in Ireland is characterised by the following major interacting forces. Global economic slowdown has resulted in an adverse demand shock to Irish economy. At the same time the export-oriented emphasis in Irish industries has suffered a substantial drop in investment and development activities. Finally, the robust growth experienced during recent years has left the majority of Irish businesses unprepared for competition in a frictionless global economy. With labour costs rising at twice the rate of productivity growth during the past 4-5 years, Irish companies appear to accumulate excess productive capacity and tolerate production and management inefficiencies. Accelerated decay in cost management, coupled with deregulatory pressures due to EU membership, currently combine to deteriorate Irish competitiveness relative to both the more productive multinationals and the lower cost producers from East-Central Europe. In the private sector this gap in competitiveness appears to be dramatically deeper in domestic industries such as retail banking, retail sales and distribution, telecommunications, real estate development and agriculture. The effects of cost efficiency losses are even more pronounced in the public sector, which suffers from all of
the above problems in addition to experiencing talent drain in favour of the private economy. Recent research2 shows that during the last expansion cycle, many Irish companies have failed to adopt best business practices and managerial technologies, particularly in the field of services and materials procurement. In many cases, steps taken to enhance management capabilities have failed to generate expected competitiveness gains. This in the main is due both to the piece-meal approach taken to innovation and the incomplete implementation of strategic innovations, which in turn is exacerbated by the general lack of commitment to change on the part of management. At the same time, complacency with the public sector fuelled by rising tax receipts has resulted in the mismanagement of funds and operational inefficiencies. In this scenario the significant degree of under-utilisation of cost and operational management know-how present in Irish industries offers substantial opportunities to strengthen Irish enterprise and public sector competitiveness. Past experience within the OECD shows that, during a contraction in the business cycle, cost management and quality differentiation act to separate the leadership fringe from the less competitive counterparts equally effectively across all industries3. The efficiency to be gained by updating existing managerial technologies yields proportionately greater benefits for those companies operating in the volatile economic environment that follows rapid economic expansion. It is for this reason, therefore, that adoption of the best cost/quality management practices can be expected to produce greater benefits in Ireland relative to the rest of the OECD. This implies that Irish businesses stand to gain far higher rates of return on procurement managerial know-how and from outsourcing this function than their counterparts in the EU. They also are posited to suffer far greater losses if they fail to adapt best practice solutions. If one factors into the equation the possible addition of low-cost competitors from Eastern Europe to the EU it can be seen that Irish companies may be in danger of losing entirely their competitive advantages which were built, in the main, on the
favourable tax and tariff treatment given to them through the membership in the EU, and much less on managerial, technological and strategic innovation. The evolutionary direction in the global economy in favour of higher cost competition, combined with deregulatory pressure in domestic markets, have necessitated a separation of the marketplace in Ireland into the strong competitive fringe and the inefficient follower core. To enter the competitive leadership fringe, both domestically and internationally, Irish companies must seek out and adopt strategic initiatives to implement best managerial practices and technologies. In the absence of the demand growth, these efforts must focus both on reducing real and nominal costs and improving product and service quality differentials with their competitors. Both of these objectives cannot be achieved without reducing both cost and technological frictions in the process of acquiring, maintaining and managing supplies, inputs inventories, real estate assets, auxiliary production, distribution, customer service and marketing and other aspects generally grouped into the categories of purchasing. Our research, supported by the consulting experience of purchasing service providers, shows that the vast majority of Irish companies seriously underestimate the importance of procurement within their business. We find that, within the domestic economy, procurement management inefficiencies have resulted in estimated losses of €4,1005,040m (X1) annually. Procurement, de facto, involves variable (e.g. inputs acquisition and output distribution), fixed (e.g. technology acquisitions, facilities maintenance, etc.) and capital (real estate, plant and transportation) costs management, thus cutting across the whole cost structure regardless of the industry specifics. However, excluding the purchasing of raw materials and intermediate inputs, proportional to total costs of operations, purchasing costs are higher in service, trade, IT and public sectors than in manufacturing or agriculture. For example, in some service industries, such as resource management, purchasing costs may comprise in excess of 70% of total operating expenses. This implies that in some industries where the core production costs are heavily weighted in the direction of the third party services (such as transportation, installation, maintenance, etc), the weight of operating costs attributable to purchasing is well above
the average 30-35%. On the other side of the spectrum, in professional services, where the main weight of expenditures falls on salaries and compensation payments, purchasing will cover a large share of non-salary costs, contributing overall to a smaller, yet still significant, share of total costs management. Despite the significant role of procurement management in cost and process control, most managers and business leaders have yet to realise the true scope of purchasing operations application to their business. Based on our survey, case studies analysis and a review of the related literature, we estimate that on average only 10-15% of the company operational costs can currently be classified as a direct responsibility of purchasing departments. Overall, it is safe to conclude that Irish industry and public services are operating below the OECD standards in purchasing cost management. A continuation of such complacent practices and failure to capture the leadership position in procurement management within the EU will undoubtedly cost Irish companies their competitive positions in the long run, with short-run deterioration in revenues and profitability.
Comparative state of Irish purchasing practices.
On the global scale, third-party providers of operational services took in more than $1 trillion around the world in 2000, according to Dun&Bradstreet. The market for providing inventory purchasing and management services and know-how has more than doubled in size from 1997 to 2000. Despite the current economic downturn, according to McKinsey and Company, the market for these services can be expected to grow by 25% p.a. over the next two years. These developments only partially reflect the importance of purchasing in overall productivity enhancement efforts in the modern business world. Up to 60% of the OECD enterprises still choose to adopt an internalisation approach to managing procurement. The figures capturing internal innovation and new managerial tactics and policies implementation are not included in the revenue value that accrues to the outsourcing firms mentioned above.
In contrast, Irish markets lag in these developments. We estimate that the value of the procurement market in Ireland is roughly equivalent to 30-35% of the national nonagricultural GDP. On this basis the total of non-agricultural markets for purchasing services comprise approximately €m 12,110 (X3) in total annual turnover in the private sector. By adjusting for domestic output growth and inflation rates, these markets have the potential to grow, on average, at 31.4-41.5% ( X 4 ) annually in the next 3 years. Thus we can expect the total turnover in the procurement services demand to double within the next 3 years. These figures are equally dramatic when applied to the public sector and general government. Under the optimistic assumption that the Irish civil service is at least as cost efficient as private sector enterprises, the value of procurement markets in the public sector in Ireland can be estimated at €4,220m ( X 5 ) annually. Discounting for political factors such as policy persistency and elections uncertainty and without correcting for traditional cost allocation inertia associated with organised labour and vested interests, their growth potential can be estimated at around 2/3 of the private markets. However, this figure may be substantially higher if adverse economic shocks result in fiscal pressures under the Maastricht Convergence Criteria. Our survey of 86 Irish and 21 multinational medium to large size firms in Ireland has revealed that only 28% of Irish companies had some integrated procurement divisions4. This figure compares unfavourably with the figure of 70% identified in the sub-sample of the foreign owned companies operating in Ireland. Wherever purchasing departments were present, our follow-up survey has further shown that operations management, more often than not, gives a lack of priority to the existing procurement solutions. The latter problems ranged from the limited transparency of the purchasing departments’ position within the companies to their lack of involvement in the purchase of strategic goods and services and a lack of established purchasing policy guidelines. In many cases purchasing remained decentralised across various other departments even though there was an official Purchasing Department in place within the company register. Most of the
registers had no mention of the purchasing agents other than the heads of offices. Using partial scoring based on the system developed by the Irish firm Purchasing Solutions5, we have ranked firms within the sample with respect to the scope and depth of their procurement operations management. We selected 6 criteria for scoring ranging from the measure of the presence of a Purchasing Department in the register to the extent of the purchasing contracting procedures in place. Each criterion was scored on the basis of increasing scale of quality of procurement management with 0 being the lowest score reflecting no evidence of management procedures, to 6 being the highest score assigned in the case of both strong presence and clear definition of the procurement procedure. Following scoring, we have grouped the sample scores into 4 tiers. The lowest tier comprised of the companies with the combined score between 0 and 9, while the highest tier included firms achieving 28-36 points. As the result, 33% of Irish and only 6% of multinationals have scored in the lowest tier in terms of efficiency and competitiveness in purchasing solutions implemented. At the same time, a general survey of the annual, quarterly and proxy reports for the random sample of 30 US-traded publicly owned companies, have shown that procurement activities contribute between 24-40% of the operating budget expenditures for medium-large size companies in the US6. Adjusting for the greater productivity/cost ratios in the US relative to those in Ireland, the results of this study shall extend to Irish firms with robust upward adjustment vis-à-vis the US results. Assume managerial expertise in Ireland does not lag the US and UK practices. By applying the productivity/cost differentials across these markets to the purchasing segment of the core business process and by improving the cost and flow efficiency of their procurement, even within a conservative 30-35% share of operating costs accruing to the procurement within the average OECD enterprises, Irish medium-large firms stand to gain an opportunity space of 37-45% ( X 6 ) of their current operating cost structure in potential cost efficiencies including price reductions, process improvements and risk management. Overall, using the results of our surveys, the annual cost of procurement mismanagement to Irish non-agricultural sectors can be estimated to be in the range of €m 4,100-5,040 ( X1). However, this range can be pushed higher due to a higher initial level of benefits
from the reforms in Ireland that can be expected under the 7-10 percentage points spread between Irish and OECD shares of procurement costs in total cost structure. In such a case, we can estimate procurement mismanagement costs to amount to €m 4,450-5,725 ( X 7 ) per annum. These figures are most likely to be higher for the services sector and export oriented manufacturers using intermediate goods as inputs, and relatively lower for the domestically oriented producers. Within the public sector, similar inefficiency costs accruing due to the procurement management losses can be estimated at €m 1,0151,200 ( X 2 ) annually.
Our analysis of the case studies conducted by the purchasing and outsourcing consultants in Ireland and the UK shows that the adoption of comprehensive purchasing management solutions by their clients has resulted in up to 30% savings (net of implementation costs) in nominal terms over a three year period. When extrapolated to the non-agricultural share of the Irish economy, net annual savings expected, due to implementation of cutting edge procurement technologies, can reach between €m 1,250-1,610 and €m 1,444-1,858 ( X 8 ) in the first 1-2 years of implementation. Adjusting for the robust Irish growth and lower efficiency of purchasing management in Ireland, these figures can rise to €m 1,530-1,645 ( X 9 ) p.a. for the first year of comprehensive reforms. In the public sector these figures are magnified by relatively faster rates of growth in government expenditures relative to those in the private economy. In general government services, net of defence, net savings due to procurement management reform can reach €m 796-1058 p.a. ( X10 ) in the first 1-2 years of implementation. In the current state of management practices in purchasing, these are pure losses sustained by Irish businesses and public sector due to procurement not being recognised as a strategic management tool, procurement technology inefficiencies and the lack of comprehensive strategies in operational cost management. Hence, Irish companies with deficiencies in procurement management stand to gain 17.5-28% ( X11 ) increase in productivity and up to 12.54% ( X11 ) profitability enhancement by improving their purchasing practices over the life span of reforms.
The figures above do not reflect the wide gap between Irish and the OECD-15 average business attitudes towards the third party outsourcing. Given that according to the Price Waterhouse Coopers 23% of Irish firms are suspicious about the benefits of subcontracting and outsourcing in general, these gains in productivity can be expected to rise substantially once there is amore widespread acceptance of these cost and quality control measures in Ireland. As the low-pressure environment of rapid economic expansion wanes, the Irish marketplace remains ripe for managerial and logistical improvements. Cost reductions, timing and quality efficiency improvements and productivity capacity enhancements offered by recognising purchasing as a strategic management function and adopting Purchasing Best Practice may serve as one of the main forces separating the industry leaders from the followers. The same measures will also serve to solidify the Irish business position in the continental marketplace in preparation for the forthcoming enlargement of the EU.
Structure and implementation of Best Practice.
How do the successful companies identify a real opportunity to build meaningful economies of scale in the context of procurement management? In analysing managerial literature we have found that successful purchasing managers design their processes by considering the following questions in three major areas: (A) Customer service impact:
1. How much of a customer’s business will be directly linked to a new strategy? 2. What cost-to-benefit ratio will enable company to capture value from innovation and to limit interaction costs to the customer? 3. How can the customer demand for service be reconciled with the standardisation required to achieve maximum value per input?
Internal compatibility: policies?
2. Can new procedures be seamlessly integrated into existing purchasing plans and 3. Will the new strategy achieve time and resource savings in the targeted area without cost shifting and inertia arising from internal process interactions? (C) Production compatibility: will it act to expand the core? 2 In case of a strategy falling outside the core business area, does internalisation of the new process within the company provide production synergies or can it be outsourced to the third party providers? In process of answering these questions, best practice solutions adopted by the leaders in the procurement technologies include the following four-stage approach. At the first stage an analysis of existing practices and technologies is conducted. To strengthen transparency and interpretability of the findings the results of the evaluation are scored against the increasing ranking scale. Standardised scale tables example would include 10-13 categories with scores representing the extent to which purchasing is structured, as well as the level of professional management expertise involved. Scoring procedures of this variety are in wide use amongst the procurement and outsourcing agents and consultants around the world. Purchasing Solutions provides a robust and successful example of such practices in Ireland. Recent academic research in innovation management and implementation suggests that periodic augmentation and revision of the categories as well as the relative weighting of each category score against the core business activity should be undertaken. Early theories of innovation implementation, such as Peteraf (1993)7, claim that rankings of managerial activities in general shall be resource-based. However, the most recent
1 Does new strategy provide an enhancement to the core business of the company or
productivity growth that accrued to service sectors suggests that rank-scoring can and shall be extended to include assessment of the capabilities and opportunities within the space of purchasing cost management and outsourcing.8 Advances in qualitative analysis techniques and in the fields of social experimentation and cultural anthropology have recently enabled consultants, such as US-based Context Research, to provide quantitative analysis of subjective capacity of products and company structures. Independent of the depth and breadth of rank-scoring, it is imperative that initial assessment be conducted by the independent service. External evaluation acts to alleviate potential dependency of the results on managerial conflict of interests, agency problems and moral hazard, as well as to correct for the information asymmetries present in any institutional environment. Following the rankings analysis, in the second stage of the process, external consultants can offer an audit-type independent assessment of the potential for practice development and improvement within the boundaries of the existing business. Combined with cost/benefit analysis, flow and employment analysis, a comprehensive list of proposals is provided for consideration. These proposals are analysed with respect to their positioning within the core business. The decision to internalise or to outsource a particular activity must be based on the analysis following the latter two areas of inquiry mentioned above. The third stage involves implementation of the new policies, accompanied by the continuous appraisal of implementation, transition and production efficiency against the benchmarks and ranking criteria determined earlier. Finally, post implementation strategy shall involve continuous regular assessment of the procurement strategies against the best practice innovations and competitors’ policies. At this stage, it is imperative that specific attention shall be paid to identifying major improvement areas and quantifying efficiencies of the newly introduced policies as well as identifying the opportunity space for new process improvements. In addition to current practice outlined above, both third and fourth stages of implementation may benefit from a quantitative model that would be able to capture
ongoing cost/benefit gains due to innovation as well as track implementation efficiency. Despite data availability and nature sensitivity, such model may involve variations of the following procedure. Let Ct,t 1 be observed difference between seasonally adjusted procurement costs.
0 if not attempted Denote by Di if c ompleted partially 1 if c ompleted
where denotes the variable capturing degree of completion of stage i in implementation process. Furthermore, let x i,i1 be the difference between the weighted ranking score attained between the stages i and i+1. A linear model:
Ct,t 1 b1 b2 Ci,t 1,t b3 x i,i1 b4 Di
j j j i1 i1 j j
can be estimated on the basis of standard available data. Parameters superscripted by stage of implementation, j, will then capture variation in cost/benefit efficiency attained during the period of implementation. Note that the additive nature of the degree of completion allows for capturing the latent synergies between the payoffs accruing to each stage of implementation. Separation of this variable into stage-specific estimates will be problematic due to severe potential multicollinearity problems in data. The model can be estimated by the OLS procedure. Variable x i,i1 is a scaled total ranking score for the company defined as a weighted average of ranking scores in each category. The weights will reflect relative importance of each score in relation to the core business activity of the enterprise and must be specific to each industry. For example, materials purchasing may be given a higher weight for an industrial facility than for a service firm. Outside the singular project involved, consulting service providers may rely on database for the completed projects to cross-reference the results of the model with the previous projects’ efficiency figures. In this case, normalisation of the model variables shall be conducted prior to estimation. Acceptable normalisation will include scaling a variable Ct,t 1 by the total revenue of the client, and x i,i1 by the industry average.
This econometric model is designed to capture the actual sources of savings and productivity efficiency improvements arising from introduction of new procurement strategy, and/or measure activity-specific gains from outsourcing. Overall, as mentioned above, purchasing management has been instrumental in introducing cost/benefit efficiency improvements in production. However, synergies realised by adopting best practices in procurement management extend beyond the achievement of a simple quantitative effect on cost structure of manufacturing, distribution and support activities. The US automotive industry serves as an example of quality improvement and maintenance achieved through the introduction of internal improvements in procurement practices and the outsourcing of some of their practices to third party providers. Dramatic improvements in the quality of vehicles and flexibility of design, allowing introduction of new models and shortening of the design-to-production timing and costs, have been accompanied in the US by revision of the long-term supply contracts and purchasing agreements. According to the United Autoworkers (UAW), the average life span of a purchasing contract within the US auto markets now ranges between 6 years for input parts to 2-3 years for business support services. In contrast, large, small and medium Irish companies often continue to retain supplier contracts that have not been reviewed or renewed in over 10-15 years. Similarly, on the customer service side, continuous assessment of procurement practices pertinent to outsourcing marketing and business services can be seen as quality improving. In 1980’s, by introducing into the computer industry major innovations in centralisation of marketing strategies and decentralisation of customer support and retail distribution, Apple Computer forced computer manufacturers to completely revise their business policies9. At the same time, the steep increases in Apple’s cost structure, that marked a period of computer manufacturer’s difficulties in mid 1990’s can, in part, be traced back to the adoption of an overaggressive outsourcing policy and the slowdown in internal management innovation. Both developments have contributed to Apple’s leadership position in customer service and quality, and point to the delicate balance required between the internal management of purchasing activities and the potential for
outsourcing some of the processes to third party providers, as well as to the scope of the learning curve resulting from the learning-by-doing approach to innovation. Finally, procurement know-how must be considered in the light of its potential to enhance both the production process and core business activities without yielding in the business support activities area. As more and more of the routine operational activities of companies become automated and computerised, seamless transitions between internal management and outsourcing can be achieved at lower costs and with greater reliability. This development has already led to the commoditisation of some services allowing for the development of economies of scale in services that can be digitally tracked and administered. The most dramatic effect of these developments can be seen in the provision of customer support services which, until recently, has been viewed by most companies as their core business. Currently most customer service providers lie outside the core business of manufacturers and distributors of actual goods and can improve core business of these companies by providing low cost, high quality routine services to customers. However, many third party providers lag behind in codifying the lessons learned from serving one account and applying them to other accounts and clients. In time, with more standardisation and digitalisation, this type of information linkage will be easier to achieve, shifting service industry away from economies of scale to economies of skill, that is to improvement of processes and the exploration of new capabilities. Needless to say, the benefits of such learning will be available exclusively to the competitive fringe of firms, which would put in place highly developed, flexible and capable procurement management. In one of the dramatic examples of such innovation utilisation, a US leader in newspaper publishing, Los Angeles Times has used a successfully designed model of decentralisation through outsourcing to consolidate internal controls over costs, distribution quality and customer support. By feeding return data from these activities to the centralised procurement and business activities management teams, LA Times was able to identify and focus on the core business expansion introducing new lines of publishing materials and services. Similarly, major drug manufacturers in the US have recently been
aggressively outsourcing their drug testing activities that were previously perceived as part of the core business. Testing organisations such as Quantum have been able to utilise economies of skill to learn across different clients and develop better testing techniques.
Irish experience: Translating Opportunities into Capabilities.
Our survey of 107 medium to large size firms operating in Ireland has highlighted the extent to which the neglect of procurement management characterises current business practices in the private economy. A similar situation occurs in the public sector. Considering a positive correlation between the size of the company (revenue and employment wise) and the extent of information coverage within the company web site, our present study has captured the leadership fringe within the Irish marketplace. Subsequently, all of the results shown in part 1 above are expected to be more pronounced in a larger sample using more direct data collection and survey design techniques in order to capture the overall marketplace. The figures discussed earlier highlight both the urgent need for the strategic revision of the purchasing management technologies as well as the opportunities for productivity enhancements and cost savings that are available to both Irish companies and public sector organisations. In essence, Irish firms stand to benefit from above OECD-average efficiency and productivity gains by adoption of the modern purchasing and outsourcing solutions relative to their foreign owned counterparts. These benefits offer additional opportunities in light of the high inflation in capital costs and capital intensities in production found in Ireland. By controlling the nearly 191%, 300% and 138% differentials that exist in capital costs inflation in Ireland vis-à-vis continental economies, the UK and the US respectively ( X12 ), Irish companies can be expected to attain greater than average efficiency gains through direct cost reductions associated with any streamlining and strategic innovation introduced within the procurement arena.
The main obstacles to managerial improvement in Ireland includes the following: 1. Ossified structure of traditional business management that stresses long-term contracting arrangements based not on cost-benefit analysis, but on information asymmetries and personal relations; 2. 3. 4. Lack of managerial, promotional and monetary incentives on offer to develop new strategies and undertake risks; Lack of vertical information flows from bottom up with the company structures; Culture of managerial complacency and myopic expectations of continued economic growth that result in overemphasised attention to upward mobility in final product pricing and lack of attention to cost structures and customer service; 5. 6. In the public sector, the presence of, and the way the EU Procurement Directives are managed, presents a substantial bureaucratic hurdle to strategic innovation; Irish Government procurement practices that often allow breaking up of economies of scale in purchasing by requiring an arbitrary number of bids (3) for each procurement line. These practices, often applied uniformly and without consideration of the specific contracting needs and synergies amongst the suppliers have disfavoured bundling and hierarchic subcontracting arrangements that would allow consolidation of several small contracts under a single large general contractor capable of utilising the benefits of scale pricing. For example, some state-owned enterprises currently channel up to 33% of their procurement contracts through the small providers with 1-3 employees involved in the actual contract implementation, instead of seeking a single general contractor who would be able to negotiate better prices and provide a better quality control over the services supplied. 7. 8. Shortage of skilled professional service providers in the field of outsourcing and procurement management consulting; Acute shortage of trained procurement professionals available for employment in Ireland. The later problem is most troublesome when one considers the possibilities for improvement in the near future. Other than the part-time diploma course offered by the
Irish Institute of Purchasing and Materials Management (IIPMM) in the third level colleges, Ireland stands to be the only nation within OECD that offers virtually no other professional training in purchasing management. Furthermore, under the IIPMM programme, some of the lecturers appointed directly by the colleges may have no knowledge of the particular subject of the purchasing management. In fact, no university in Ireland offers a comprehensive BA or MBA program in any aspect of the Supply Chain including procurement. This contrasts vividly with the UK where at least 6 universities provide training at BA level and at least 4 extend it to MBA degrees. Furthermore, every major business school in the US offers coursework in this field under the BA and MBA degrees. Yet, at this point in time, only one college in Ireland, namely Carlow RTC, offers a purchasing related degree course, initiated only within the past year. A further fact is that there is a complete lack of procurement and cost management R&D facilities or involvement by academics in such research and development. Private sources of education, training and innovation, such as the IIPMM are under-funded and understaffed whilst the public education system is completely insufficient to satisfy current needs for professional training in the field. At the same time, it has to be said that the general underdevelopment of customer service, maintenance and quality differentiation in Ireland’s domestic industries provides added opportunities for gains from purchasing management upgrading. These claims are best exemplified by the experience of two Irish-market competitors. Adjusted for market share, customer niche and revenue size, both the ‘A’ and ‘D’ compete in the same market. However, ‘D’ successfully implemented a comprehensive outsourcing strategy, resulting in payroll reduction to around 20 members of support staff. ‘A’ at the same time, keeps nearly 180 staff labour force in core business support positions. Whilst ‘D’ strategy has not been detrimental to quality of service, it has yielded savings estimated at between €m 5.9 and 6.2 per annum.
In the time of transition from low cost, low tax environment to mature cost/productivity competition on par with other EU competitors and simultaneous pressures from foreign competition, it becomes absolutely imperative for the future survival of Irish companies to reverse the hitherto fairly complacent attitude adopted by management to Purchasing as a strategic management function. Consider, for example, the UK experience. According to a multitude of observers (such as the Economist and WSJE), over the last two decades, UK companies have consistently failed to adopt best managerial practices in day-to-day operations. These developments have resulted in the decline (in real terms) in UK productivity and contributed to an ongoing shift in ownership of UK firms in favour of foreign management and lower than anticipated rates of economic growth. On the other hand, multinational companies and foreign-owned British firms have been gaining in both productivity and profitability due to their ability and willingness to adopt new strategies in cost and productivity management. Transformation of competition space from direct product differentiation to managerial skill innovation and cost management, coupled with the decline in the importance of tax and wage structures will undoubtedly exacerbate pressures on Irish managers to reform business processes within domestic companies. Quoting McKinsey experts : ‘Today, these facts should give all managers pause, for the world economy is on the verge of a broad, systemic reduction in interaction costs. The business executives will be forced to ask the most basic and discomfiting question: What business are we really in?’10 The answers will determine their fate in an increasingly frictionless economy. Any successful answer will require a balance between the pressure of the production side of the company to internalise procurement operations and the needs to enhance cost efficiency and flow structure via outsourcing on the support side of the business core. The latter objective can be achieved by the means of central planning, selective procedure standardisation and simultaneous externalisation of business processes. These measures fall into the category
of purchasing management and will allow medium and small size national companies to capture the economies of scale available to the larger and more advanced multinationals. Overall, in this age of change awaiting Irish business, both survival and prosperity of domestic firms are firmly nested in their ability to adopt best practice solutions to cost management and purchasing processes. The potential threats of failure to reform as well as the benefits of strategic innovation in this field of management are hard to overestimate. The following one to three years will see the rapid disappearance of noncompetitive, ossified company structures and realignment of leadership positions in all sectors of Irish economy. Those who lead today in procurement technologies will undoubtedly become quality and profitability leaders, while those who follow will either see their share in Irish and export markets collapse in size or face outright bankruptcies. Bright days of carefree economic expansion are over. Today we are entering the age of survival of the fittest. We shall look for the purchasing management innovators to establish a pecking order for the future successes and failures.
Data Sources and Estimation Formulae.
Using OECD, CSO, Department of Finance and other sources of data, we identify the following main statistical parameters used in imputation of the analytical figures shown in the text: the average figure for maximum share of operational costs accruing to purchasing; A2 0.1;0.15 current share of operating costs covered by purchasing solutions in Ireland; A3 0.1;0.15 growth rate for general government expenditure, per annum (nominal); A4 0.1;0.15growth rate for manufacturing (nominal); A5 0.12;0.18 growth rate for non-manufacturing component of industry (nominal); A5.1 0.154 growth rate in volume of production indices (manufacturing, transport);
annual growth factor for purchasing industry; A6 0.25 A7 0.3;0.35fraction of non-agricultural output accruing to purchasing activities (see text); A8 103,479€ m Irish GDP (2000); A9 87,122€ m Irish GNP (2000); A10 2,872£m Irish agricultural GDP (2000); A11 30,781£m Irish industrial GDP (2000); A12 11 ,803£m Irish transport and logistics GDP (2000) (note: these include the services in procurement currently in place) A13 2,460£m government production (2000); A14 7,974£m net government expenditure (2000); A15 77,950€ m Industry, gross output; A16 44,563€ m Industry, net output; A17 6,4341€ m Industry, wages; A18 38,132€ m Industry, remainder; A20 0.046 0.043 GDP deflator for OECD, 2002-2003; A21 1.012 deviation in actual GDP from potential GDP (measure of excess industrial capacity); competitiveness measure (2000), Ireland, relative labour costs. A22 0.75 A23 1.144 competitiveness measure (2000), US, relative labour costs. A24 0.837 competitiveness measure (2000), Euro zone, relative labour costs. A25 0.24 0.4 survey data for the MNCs operating costs coverage; survey data for Irish domestic firms market coverage; A26 0.28 survey data for the MNCs domestic firms market coverage; A27 0.7 first year yield from reforms; A28 0.30 private vs. public reforms efficiency factor (see text); A29 2 / 3 capital cost inflation (US); A30 0.05 A31 0.023 capital cost inflation (UK); A32 0.036 capital cost inflation (Euro zone); A33 0.069 capital cost inflation (Ireland); List of Formulas: Private and Public sectors figures:
A7 A 1 A4 A121 A51 A2 B1 0.79 11 B1 B1 X1 3.8125 compoundedgrowth at A6 avg.min/max:
similarly for X 2 :
A7 A A141 A21 A3 B2 0.79 13 B2 B2 X2 3.8125 compoundedgrowth at A6
These figures reflect adjustments for: sectoral growth rates, current coverage by procurement technologies and purchasing industry growth rate.
X 3 avrg A11 A12 A2 A7 1
Total non-agricultural markets for purchasing in terms of annual turnover, adjusted for currently achieved coverage and potential coverage.
A4 A19 B4 A1 1 A20 A5
X 4 A6 min/ max B4
Hence, average annual growth rate in private markets reflects weighted growth rates in the sectors and inflation effects. For public sector figure X 5 we include defence spending in computing figure
For private opportunity space estimate: X 6 , we compute relative competitiveness in Ireland vis-à-vis Euro zone (we avoid the US and the UK to minimise problems of exchange rate appreciation of the dollar and sterling):
2 1 X 6 A7 A4 A5 B6 1 1 3 3
Mismanagement costs: to obtain X 7 we re-compute X1 using figures from X 6 instead of A7 factors. Net annual savings from reforms (private and public sectors):
X 8 0.5X 7 A28 A2 X 7 0.3 1
so that private savings are the average of normalised (by current coverage) and gross inefficiency levels for the first year. For the second year savings, we use the above result and adjust it upward by the growth rate of industrial output:
2 X 8 X 8 A5.1 1
Furthermore, adjusting above figures to reflect more robust growth of Irish economy as a whole (relative to OECD average), and to reflect the lower current efficiency of procurement solutions in Ireland, we arrive at:
X 9 X 8 X 6 A7 1
For public sector the same figures are:
X10 X 2 A3 X 6 A7 A29 1 1
The potential gains in productivity are computed as follows: using current productivity growth in Ireland (2% average over the last 5 years: Honohan-Walsh, 2002), we add potential productivity growth factor adjusted by potential coverage achievable (US level) and current coverage present in Ireland:
A X11 avrgmin/ max 0.02 27 A25 A2 min A7 1 A28
while profitability figures are derived by weighing X11 by the opportunity space for gains in Irish marketplace, identified by X 6 . Finally, for capital cost ratios:
A33 , where i=0 for the US, i=1 for the UK, i=2 for the Euro zone average. A3i
Contact information: Department of Economics, Room 3016, Arts Building, Trinity College, Dublin 2, Ireland. Phone: 353-1-6081522, e-mail: firstname.lastname@example.org. Author thanks John Barry, Gavan McGirr of Purchasing Solutions and Sean Carberry of OmniMedia for helpful comments, data. All errors and omissions are mine. 2 Gurdgiev, C., Learning from other Tigers. Linking Irish Productivity Growth with Economic Crisis. Open Ireland, Vol. 1, Number 4, 2001 3 Collins, D.J., Montgomery, C.A. Competing on Resources. Harvard Business Review, July-August 1995. 4 The survey involved web site analysis followed by the phone survey, whenever no conclusion could be drawn from the web site materials. The non-response rate to the follow up survey was 15%. Zero observations accounted for approximately 6% of the sample size. 5 Hereinafter we refer to the materials obtained as the result of an interview conducted with the representatives of Purchasing Solutions.
The survey was conducted on the basis of random selection, censored by availability response. We believe that the data obtained represents broad market, unspecialised by industry attribution. No firm size bias is suspected. 7 M.A. Peteraf, The Cornerstones of Competitive Advantage: A resource-based view. Strategic Management Journal, 1993, Number 14. 8 see Holmstrom, J., et all Case Study : Wurth Oy , McKinsey Quarterly 2002, Number 1 9 Hagel, J., Singer, M. Unbundling the Corporation, McKinsey Quarterly, 2000, Number 3. 10 ibid, Hagel, J.