The Market Basket Focus Areas Pay Concept
By Dr. Tom DePaoli
Jack Welch once noted that the only two departments that drive revenue directly to the bottom line are sales and procurement. He noted that the other departments were basically overhead. I would also include supply chain professionals in this revenue generating group.
The dilemma that we have is how should organizations pay the revenue generating departments of procurement or the supply chain? Sales departments are often incentivized with bonus-based pay based on sales volume, increases in market share or new customers gained. Should we pay them similar to sales? Not so fast.
Here is a story. I once had a very good steel buyer who led our steel supply chain efforts. Steel was approximately 25% of our cost of goods sold. In his review he showed that he had achieved a price reduction for the year of 2%. He focused solely on cost. However, the overall market or market basket price of steel we used had fallen 6% that year. Obviously he had not kept up to the market’s price reduction. We did have a discussion that revealed that he had a potential breakthrough project with the supplier to us a different significantly less expensive grade of steel that would reduce our steel cost by 20 %. The new grade of steel took less time to produce, was closer to our plant, required fewer inventories and had major quality improvements. For this year’s review it was mentioned but we agreed to include it in next year’s goals.
For procurement and supply chain professionals’ metrics for pay increases is much more complicated, but revenue growth or hard savings must at least ground their pay or compensation system. Unfortunately many of our colleagues cannot get past “price or cost is king.” which requires ongoing education on procurement’s part, and the use of total cost of ownership principles. There is not a shortage of focus areas to help select how to judge compensation for procurement or supply chain professionals. Quite the opposite there are almost too many! A varied market basket (multiple focus areas) approach is justified.
My first point is that when the multiple market focus areas are selected to judge compensation are selected, they should be aligned to the organizations overall vision and mission statement. They must be adjusted for the current market conditions the organization is facing. They should vary year to year based on market conditions and circumstances. In the dynamic departments of procurement and the supply chain, the worst choice would be to select a system that is inflexible and outdated. I recommend a focus area market basket approach and for simplicity no more than five or six focus areas. The list of focus areas available is large.
I realize this is a large list and that I have not gone into great detail on many of the focus areas. I am sure a procurement department can brainstorm even more focus areas. One of the most important steps is to get another department such as finance or accounting (a third party) to agree to the definition of the focus areas and the criteria. Without their buy-in, procurement’s savings or success will not be recognized.
Here are some market focus areas to consider:
Market Basket Focus Areas Hard Savings
- Actual price reductions,
- Reductions in freight costs
- Reduction in lifecycle costs
- Reduction in internal labor costs
- Reduction in transaction costs
- Reductions in consumption or waste
- Cost avoidance especially capital spending
- Reduction in unit cost of operations
- Reduction in unit cost of production
- Reduction in overhead cost
- Reduction in transportation cost
- Reduction in manpower and labor costs
- Increased throughput, resulting in increased sales or revenue
- Reductions in inventory
Market Basket Focus Areas Soft Savings
- Better supplier management and less suppliers to manage
- Certifications and professional educational improvements
- Conformation to any changes in the law without additional costs
- Crisis management improvement
- Cross functional team leadership and education of other personnel in the process
- Customer service performance improvements
- Demonstrated leadership skills and improvements in trust
- Elimination of bureaucratic work and procedures
- Faster on-boarding and better capabilities of new personnel
- Fewer misunderstandings between different teams, sites, cultures, and languages
- Fewer process disputes between in-house staff and third-party suppliers
- Improved scheduling and forecasting as part of capacity and demand management
- Improved service support and service delivery to end-users by suppliers
- Inclusion and collaboration with colleagues and other departments
- Increased customer satisfaction and loyalty
- Increased employee satisfaction and reduced turnover
- Increased safety in the workplace
- Industry expert status–publications and recognition
- Innovations especially joint ventures with suppliers
- Internal customer satisfaction with procurement and the supply chain
- International supply chain skills
- Better IT and technical skills and use of recent advances
- Less research time spent finding templates and researching how to do things
- More effective governance, portfolio management, time tracking, project management, cost management, and resource allocation
- More upfront involvement of key stakeholders who can provide earlier feedback
- Overall product knowledge not just components knowledge
- Process improvement, reduction in process steps and time to market, Increased product quality due to use of best practice standards — more appropriate requirements, design, and code reviews; more effective testing; etc.
- Reduced design and re-work time
- Reduced need for methodology and skills training for in-house staff
- Reduced time spent in meetings and administrative work
- Reduction in the need and tie up of working capital
- Reduction in overall process or cycle time
- Relationships building, improving collaborative venture with suppliers, sharing computer systems and improving communications
- Better Voice of the Customer understanding
- Seamless and rapid adaption of new technologies
Finally, I would recommend adjusting or changing the market focus areas for each procurement or supply chain professional yearly to improve their breath of skills and capabilities.