Good Procurement is not about Savings
Should reducing spend as much as possible be the main purpose of procurement?
This analysis of two well-known global retailers suggests not, since the cost-cutter fared much worse. But what can you do instead?
The one who focused on minimising unit prices had a hard time, with profits flat over 10 years – even though in 2002 it had three times more sales than its competitor (the red line on the graph). By 2012 David had overtaken Goliath, and now sold 30% more, and their 2012 profit was almost the size of their sales in 2002 – a 700% increase (blue line).
And it didn’t do this by cutting its supply costs.
This article was first written in 2013, and published on my previous – now closed – website. I also posted a version on LinkedIn in 2016.
Whilst cost has a key role in business, and good businesses pay as little as they need to for what they need, that by itself is not enough. Your supply base needs to help you achieve your objectives, and I don’t know any organisation whose overarching goal is to reduce spend. If it was, close everything down, spend minimised, goal achieved!
Back to the case. The two companies I studied were the UK retail bellwether Marks & Spencer (M&S) who in 2002 had sales of £8 billion making a profit of £500 million. The rival is Spain’s Inditex – best known for the brand Zara. In 2002 it had sales of £2.5 billion and made £300 million in profit. By 2012 M&S achieved £10 billion of sales, with an average profit of £550 million across the decade. Inditex/Zara’s sales were now £13 billion and had averaged £1 billion in profits each year over the decade. In the graph M&S’s profit is the red line, Inditex’s the blue dotted line.
Blinkered Procurement
Imagine you work in the global retail industry. If you focus on functional savings or PPV (purchase price variance), and want the lowest price per garment, you might consider sourcing tactics such as:
- Buying from countries where labour costs are low such as in the Far East
- Buying in bulk to obtain volume discounts
- Buying from a smaller number of larger suppliers to further consolidate volumes and simplify supplier management
- Buying well in advance of your requirement, to give suppliers more time to manufacture, and to allow extensive market research, sourcing and negotiation.
- Shipping by sea
By the early 2000’s M&S had done just this – moving its suppliers from mainly the UK to Eastern Europe, North Africa, and Asia in search of lower unit prices.
Although this is tempting logic, how is it that Zara – whose clothes are not designer-label expensive – managed to grow and make higher profits, with what seems such a high cost operation? During the period studied
- It is reported that half of Zara’s suppliers were Spanish, another 25% European, and only 25% from elsewhere in the world
- Zara orders small quantities regularly at short notice, rather than bulk orders in advance
- Zara replenishes store stocks frequently – usually twice a week. Order Monday, delivery comes Wed/Thurs
- Zara uses air freight for getting garments to stores. The world is served from a single Spanish distribution centre
- In a typical year it introduces some 11,000 products, whereas a typical competitor might introduce 3,000. Traditional logic says “smaller production run = higher costs”
So how has it managed to grow sales and profits every year for 20 years, and to deliver a return on assets of over twice the industry norm….when it didn’t focus on minimising the purchase cost of everything?
The retailer’s dilemma
Tradition fashion follows a well-trodden path.
Design – Buy/Manufacture to Forecast – Deliver to Store – Sell during Season – Discount Sales of unsold items
Design might take place 12-15 months before the season, in order to allow the required volumes to be purchased at the best prices. Buying a season’s quantity at a time helps reduce unit-prices and transportation costs to a minimum.
But once garments hit the shop floor things do not always go to plan. Customers love some items…and they sell out within a few weeks. Lost opportunity. However others did not seem to sell at all, leading to the rise of the Outlet Mall and end-of-season sales. Which in turn makes things worse – “I like that, I’ll come back when the sales are on”…or “I’ll pick it up in the Outlet Mall in 6 months”. What to do? Get better at predicting the future?….
A dilemma: Keep high stock to ensure you get every sale possible…whilst at the same time keep as little stock as possible so you have fewer unsold items and so you can carry a wider range (assuming you have limited space & cash).
Fast Fashion
Zara broke that dilemma with a different approach, which its founder Amancio Ortega called “Fast Fashion“. If you speed up the supply chain, the need to forecast almost disappears. With Zara it takes around 4-5 weeks from first design to a garment in the store. A minor modification, or making more of a popular garment, is less than 2 weeks from factory to store.
Fast Fashion brings many benefits which help grow the top line and increase the profit. It does reduce cost, not at a detailed unit-price level but at a more strategic level.
- Distribution is highly automated and “low cost”. Spanish garment manufacturers are small and flexible, but their labour rates are 6-16 times higher than the Far East
- European road distribution is as cost effective as sea freight from China.
- Stores are less crowded. They don’t need stock rooms, and they don’t need large quantities of popular sizes because sales can be replenished within a week. This gives a more “up market” feel to the store. So freight costs are higher, but store cost/m2 of sales area is lower, as is store cost/annual sales.
- Having less stock means they can carry a larger range of designs – increasing the chance there is something that appeals to a customer
- Styles can change much more frequently – no longer limited to four seasons a year. Zara customers are reported to visit some 17 times a year compared to 3 visits pa for the average retailer.
- There is less unsold stock to sell off. It is reported Zara sales are 30% of the size of their competitors, and their discounts are less.
- Their working capital is lower, stock turns are higher – with the same amount of investment in stock they can have more choices for customers. They can also grow faster without needing external finance due to the smaller store size and the lower inventory investment.
Save by spending more
I would be surprised if the price Zara pays for a shirt is lower than M&S, and very surprised if the freight cost per item is not higher. It is easy to imagine a keen but naïve buyer suggesting that Inditex should buy in bulk, ship full containers by sea, and have fewer products, so that it could reduce its costs. And I’m sure if it did this then there would be a noticeable increase in profit in the short term. But this would be the wrong thing to do. Very soon sales would fall too. Inventories would rise, tying up money, and leading to heavily discounted sales. Profits would plummet, CEO’s would get sacked, and a great company destroyed.
I’m sure Inditex doesn’t pay more than it needs to for its locally-produced garments, or for its air freight, and gets a great deal when building its offices and warehouses. However I don’t believe it spends much time considering moving back to designing a year ahead of sales and ordering all its stock 6 months before the sales season, just to lower its unit item price.
Fast Fashion doesn’t just rely on traditional suppliers. It needs suppliers who are flexible and adaptable and can produce small batches quickly and cost-effectively. This is quite possible, but not if the manufacturer has a traditional (large order well in advance) mind-set. I would be surprised if Zara, like Toyota, has not helped their suppliers to improve during its journey – there is no way they could have grown if manufacturers had said “Sorry, 4 months lead time is the best we can do”.
The bottom line
- Procurement should be all about aligning your supply base to your organisation’s objectives.
- If you don’t know how your business makes money, or your public-sector employer delivers service, then how do you know what a good supplier and a good deal looks like?
- If you only focus on paying the least amount for the service/goods specified, then don’t complain about “procurement not being respected in this business”
- If you can’t find the suppliers you need today, develop them tomorrow. You won’t become a great business just by buying what suppliers happen to offer to the market – no matter how low a price you can get!
- Save on advertising by being good, not by squeezing marketing agencies rates. Zara doesn’t need to spend much on advertising, maybe because it spends more on air freight and local manufacturers….Now how do you put that into a savings report and get it past the CFO?
Footnotes:
- I don’t claim that purchasing alone is responsible for the performance difference between M&S and Zara, but I think it is a great illustrative case of how great companies have better supply chains – not just the cheapest suppliers.
- More recently Zara has gone a step further with many ranges. They don’t even replenish fast movers – once it’s sold it’s gone. This creates a customer buzz and pressure to buy now. It still relies on it being able to make very short production runs very quickly at good margin, replacing fast-movers with a new range rather than restocking.
- It is reported Zara can get garments made popular by celebrities into stores within weeks – their fast supply chain means the cost of failure is low. Junior designers can easily try ideas and there is no need for time-consuming senior-level committees and approvals. Madonna wears a great top on tour – you can buy something similar in 5 weeks. The Economist reported, “When Spain’s Crown Prince Felipe and Letizia Ortiz Rocasolano announced their engagement in 2003, the bride-to-be wore a stylish white trouser suit—which raised some eyebrows among those concerned with royal protocol. But within a few weeks, hundreds of European women were wearing similar outfits”—designed, made, distributed, and sold by Zara.
- In March 2013 Forbes magazine reported Amancio Ortega, Inditex’s founder is now the world’s third richest person, just ahead of Warren Buffet. His ex-wife Rosalia Mera, who recently died, was reportedly the world’s richest self-made woman. HE was 3rd in 2014, but fell to 4th in 2015 as Warren Buffet overtook him!
- I went into a large city-centre M&S store in December 2012 when I was in the UK. The high piles of goods just looked depressing – they must have had the whole festive season’s forecast sales out on the floor. All that effort (and cost?) to design great looking packaging undone by poor point-of-sales display. It looked like a pile-it-high-sell-it-cheap store. I suspected someone thought it would be better, and costs would be lower, to have a single delivery and order in bulk. I didn’t spend much – I just wanted to get out. I’ve checked other M&S stores too – they all seem the same.
As a Brit I love the idea of M&S, and wish them every success.
If you read this and know someone who works there, please send them a link to this article, or suggest they buy a copy of Eli Goldratt’s book “Isnt In Obvious“. For less than $20 it will show them how to run a fast retail or distribution supply chain – better than just copying Zara without understanding the fundamentals.
Goldratt’s book is an easy to read novel, that explains the overall approach to applying a pull supply strategy in a retail environment, and is very accessible.
For a few dollars more you can get a fully detailed text book on DDMRP by Ptak & Smith. DDMRP in my view is the best way to design and manage your supply chain available today. This book will tell you exactly how to implement the kind of approaches Zara intuitively developed for themselves.
No army of consultants, no need for a $multi-million computer system to “forecast better”. Another fantastic “saving” for the company, but another one that you might not be allowed to claim!
About the Author Ian
Ian is an academic and consultant who helps improve the performance of capital projects and programmes. Hi early career experience included 15 years working as a project manager on capex projects, 10 years in procurement, including being chief procurement officer for a large construction company, and 10 years management consulting with niche consultancies in supply chain and procurement.