By James M. Baehr & Mary Ellen Mitchell
What if you were a builder and every time you opened your toolbox to complete a project you pushed aside one of your most important tools?
Why would you do that? There may be reasons. Maybe, you don’t know much about the tool. Maybe you tried to use it a few times and weren’t comfortable or satisfied with the results. Maybe you weren’t taught how to use the tool. Maybe others don’t use the tool so why should you.
This is essentially what’s happening with ‘supply management’ in public water and wastewater utilities. The functions are there, but underdeveloped. Some utilities might challenge this assertion but it’s difficult to find articles or case studies that provide evidence of related achievements.
Public utilities’ procurement groups are good at applying traditional processes. When bidding or buying they follow all the steps to select the lowest bidder. This may seem a contradiction, but with finances constrained, is this the most efficient and effective way to spend a utility’s funds? Effective revenue management requires effective spending management. Low bid doesn’t assure value. Low bid isn’t strategic. At a time when operations and maintenance (O&M) personnel and the capital budget account for an estimated 85 percent of a typical water system’s expenses (according to the U.S. EPA’s Office of Water), traditional buying methods aren’t the right tool for water managers.
Supply management alone can’t address all water-related revenue challenges, but it can certainly help utilities do more with the funds in hand. It can yield significant value and cost reductions in the range of 7 to 10 percent on both operational and capital spending. Standing in the way is traditional thinking and inertia. Most importantly, this is not about change – it’s about transformation. Change will only address a problem or challenge at a point in time. Transforming supply management in the water sector is crucial to preparing for meeting financial challenges now and in the future.
Limited Evidence
A search of the internet produces only a few examples of supply management accomplishments in the water sector. There are two instances that show the water sector can do more with supply management. The first is an article published in August 2012 by the Institution of Civil Engineers. The authors, Neil MacKenzie and Barry Tuckwood, call for “more effective procurement leading to real cost reduction and service enhancement on a sustainable basis.” A year later in 2013, the United States Conference of Mayors published a piece by Richard F. Anderson, Ph.D., senior advisor to the Mayors Water Council in which he identified several “elements of value” that are requisites for most purchases: purchase price, internal costs of procurement, time-value of money, after purchase support, reliability, operating costs and manufacturer’s experience.
Unfortunately, there’s not much information showing these recommendations have been adopted. Modern procurement methods were introduced in the 1980s by Peter Kraljic in the Harvard Business Review when he declared that “Purchasing must become Supply Management. Water and wastewater utilities are arguably using 20th century supply management practices to address 21st century business challenges.
What Is Supply Management?
The Institute for Supply Management (ISM) defines it as “the identification, acquisition, access, positioning, management of resources and related capabilities the organization needs or potentially needs in the attainment of its strategic objectives.”
A supply management group should manage the buying processes, develop purchasing strategies to support business strategies, scrutinize compliance and risk, create strong relationships with internal clients, optimize owned inventory and oversee supplier relationships. When done well, supply management can enable a utility to better control its Total Cost of Ownership (TCO) and deliver cost reductions. The utility can then apply these cost reductions to where they have the most impact.
Spend data and data analytics are vital elements to efficient and effective supply management. The information is used for planning, forecasting, materials management, performance monitoring, risk assessment and more. These are the factors that influence both the operational and financial performance of an entity.
The Current State
The EPA estimates that drinking water utilities will have to invest $384.2 billion over the next 20 years to address their deteriorating infrastructure needs. According to the Government Accountability Office, one-third of water utilities that have deferred maintenance because of insufficient funding, report that 20 percent or more of their pipelines are nearing the end of their life.
Surveys, articles, webinars and conferences immediately and consistently call to attention the dilemma of aging infrastructure and ever-increasing operating costs. The discussion then shifts to funding and the associated need to increase rates or rework rate structures. But reworking rate structures can be imperfect at balancing total costs against total revenues.
Per Black & Veatch in its 2016 ‘Strategic Directions’ report, “water service providers know that after decades of deferred maintenance, traditional revenue approaches aren’t raising enough capital to pay the bill that is now due.” The Water Infrastructure Finance and Innovation Act (WIFIA) program provides some optimism but there are no guarantees.
There’s also the debate that this challenge is not as much financial as it is about planning and asset management. Add to the mix the reality that AWWA reports renewal and replacement (R&R) requires “justifying R&R programs to ratepayers.” Thirty-nine percent of respondents to AWWA’s 2017 State of the Water Industry survey identified the need for justification as a critical issue.
These references call for financing and planning (asset management) bolstered by good communication to assure ratepayers that their monies are being spent wisely.
Triangulation: Finances, Asset Management, Supply Management
Asset management is becoming more prevalent as is the means for maintaining a desired level of service at the lowest life-cycle cost. But even if funds are spent accordingly, there’s no assurance that the lowest life cycle cost is realized.
To sustain performance, spend optimization must become a priority. Per the current acquisition practices of water utilities, the selection of the lowest is probably not producing the best value. Low bid is just that. It gives little, if any, attention to innovation, market conditions and risk management. It foregoes the opportunity to negotiate. Overlooking these opportunities to optimize spending for R&R initiatives, operations and maintenance or other projects makes it difficult to assure ratepayers and funding entities that their monies are being spent in the best possible way.
Good system stewardship requires the triangulation of finances, asset management and supply management. Making a change to one functional element of the triangle impacts the other elements. Finances provide the base support but asset management and supply management must be synergistic – working together to produce the best possible outcomes when using the finances.
The role of finance is clearly defined. The potential of asset management is well accepted. But, what about supply management? To maintain the integrity of the triangle, supply management must be more than just the buying of goods and services or the supervision of inventories. Good supply management, as noted earlier, must be strategic and total cost driven.
The Differences between Buying and Sourcing
There are three ways to acquire goods and services: purchasing, which is following a process to acquire something in return for payment; procurement, which adds some special effort to the buying process (e.g. comparing competing products); and, sourcing, which requires being proactive and applying buying strategies to support the needs of the business over time.
Water related utilities traditionally purchase (buy). Procurement tends to limit its role to processing three bids and awarding to the lowest bidder. It’s primarily buying. It’s sometimes procurement. It needs to be sourcing.
Purchasing groups are often short on resources. They’re consumed by tactics. They’re preoccupied with rules and the need to follow the rules. They likely don’t have the capacity or skills needed to move beyond the basic process. In many cases, utilities have insufficient experience with sourcing and as a result they overlook value. There’s a need to better understand internal client requirements. There’s a need for awareness of the additional proficiencies that a supplier can contribute. Quality and service should be negotiated rather than prescribed. The traditional process doesn’t deliver the best possible output or achieve the best possible outcome.
Water utilities typically don’t engage in buying their raw materials (not true in all cases). This type of direct purchasing, usually drives the organization’s sourcing strategy. It take’s considerable skill to ensure that the cost of the inputs/raw materials don’t negatively impact the pricing of the outputs/products. Historically, the involvement of a water utility buying group is limited to handling operational related buys (OpEx). They also process the bids to support capital projects (CapEx). Because of time constraints, the buyer doesn’t have time to learn the market, look for alternatives or research procurement best practices (how others are buying the same good or service). These same factors affect the buyer’s ability to build internal or external (supplier) relationships. Being focused principally on methods limits the potential to learn.
The Different Functions in Supply Management
Purchasing – The act of buying something in return of payment following a structured process.
Procurement – Acquiring/obtaining products and/or services through special means or effort.
Sourcing – The proactive searching for good/services and the application of buying strategies intended to meet business needs over a period of time.
Inventory/Warehouse Management – Overseeing, controlling and tracking the ordering, storage and use of components used in operations.
The Impact
As noted, a utility procurement group is often consumed by process – more work now for less output later. The ordering process takes so much time that it causes backlogs.
Some of the other implications:
- Buying project-by-project or purchase order by purchase order diminishes leverage with suppliers.
- Gravitating to riding other contracts becomes the path of least resistance. This relinquishes leverage with suppliers and sometimes results in being driven to buying goods or services that are one-off and that don’t satisfy the needs of the internal customer.
- Minimizing the opportunity for negotiation.
- Defining risk as something covered by insurance versus understanding market and/or supply risks.
- Overlooking alternatives by disregarding a supplier’s recommendation to do something that could be more efficient or cost effective.
- Accepting the lowest bid can result in using inferior products with less support from the supplier
- Creating situations – Engineers overdesign/overengineer and operations over-order to ensure availability.
Inventory and Warehouse Data Management
Many water utilities operate warehouses and maintain inventories. This is a supply management function, or should be. Improving the inventory management process needs to be a priority. Operations, maintenance and contractors rely on these inventories for timely repairs and completion of projects. The cost of materials and supplies can be better managed by effective coordination between buyers and warehouse managers. Otherwise, excess or obsolete inventories will increase the cost of operations and consume funds that could be available for others business needs. Undoubtedly the major issue in managing warehouse materials is having reliable, accurate data. Having multiple warehouses often results in redundant and obsolete materials that go unaccounted for, and sometimes fail to exist even though they appear on the inventory system.
Looking to Technology for Solutions
Having access to accurate data in a consolidated format is a huge advantage in understanding the company’s spending, suppliers, assets and warehouse management. Technology currently exists that allows for this integration, but few have implemented it. Applying technology to supply management enables the creation of great analytics that can be used to make key strategic decisions with confidence. It makes the difference between business as usual and knowledgeable decision making.
The Workforce
It’s important to accept there’s a need to position supply management for a rapidly changing and uncertain future. The expected changes in the workforce could result in a loss of deeply experienced professionals and increase the need for water utilities to be more dependent and demanding of contractors and suppliers. Supply management will be expected to be handle this responsibility. Unless the supply management group begins to develop these skills now, build its capacity and refine its role, it may be difficult to attract the best and brightest supply management professionals.
What to Do
Organizations are continuously introducing change, reacting to internal and external stimuli, but the change is often temporary. Just as finances and asset management are driven by strategy there needs to be a supply management strategy. The approach must be holistic versus purchase-by-purchase or project-by-project. There is a real opportunity to drive out costs through innovation and real risk through inaction.
The first step is to assess what can and can’t be done. An assessment of current people and processes will identify the capabilities and capacity of the Procurement group. Opportunities to reduce costs and maximize value can be identified and the level of effort to achieve them should be determined. This enables the utility to decide how best to proceed.
If the decision is made to go ahead with transforming there must be a firm commitment by senior management and at all levels within the utility. Transforming supply management requires cross functional collaboration. A communication plan is essential so that all employees understand the strategy, the commitment and the benefits to be realized.
Finally, the transformation of purchasing to supply management in water and wastewater entities can and is being done. The Washington Suburban Sanitary Commission (WSSC) is an example of such a transformation. At the February 2016 Utility Management Conference presentation in San Diego, WSSC announced it had realized more than $15 million dollars in savings over the initial two years of their transformation. These cost reductions were boosting working capital and supporting infrastructure and production investments. WSSC has continued to pursue their initiative, and in a recent update to their commissioners, showed the benefit has doubled to more than $30 million. The reductions have been realized in both expense and capital across chemicals, ductile iron pipe, fleet, PCCP, tank rehabilitation and water main replacement.
James M. Baehr
Founder | Sourcing Strategies Group LLC
Jim Baehr is the founder of the Sourcing Strategies Group, which supports the supply management needs of clients in both the public and private sectors. He has also served as an independent advisor leading transformation initiatives and supply management projects for chemicals, energy, retail and water clients.
Mary Ellen Mitchell
President | SpendCheQ
Mary Ellen Mitchell is the president of SpendCheQ. She is a highly experienced supply chain professional with extensive consulting and advisory experience in global procurement, supply chain and spend management at a strategic and operational level.
