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October 22, 2014
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Procurement

Leveraging private sector practices in the public sector

Supply managers who work in the public sector must comply with unique transparency rules. Despite those and other constraints, they can achieve substantial savings by integrating the public sector requirements with privatesector supply chain management concepts.

Imagine that you oversee purchasing and that the prices you pay for goods and services are public information. What's more, your bid openings are public events that suppliers and other interested parties are invited to attend. To most supply chain management (SCM) professionals that would be an unusual (and probably uncomfortable) situation, but for managers in the public sector it's a typical scenario.

As that example suggests, supply chain managers who work in the public sector face an extra challenge that most of their private sector peers do not: the need to comply with transparency and procurement rules that are typical of federal, state, and municipal agencies. Despite those constraints, public sector managers can still achieve savings ranging from 5 percent to 25 percent per commodity. To do that, they must integrate the public sector requirements with such private sector concepts as strategic sourcing, supplier relationship management, and inventory management.

Applying private sector SCM principles to the public sector could potentially have a huge cost impact. In a 2009 report, the consulting firm McKinsey & Company noted that public sector purchases of goods and services account for 5 percent to 8 percent of gross domestic product (GDP) for most Organization for Economic Cooperation and Development (OECD) countries.1 And a recent opinion piece by David Yarkin in The New York Times discussed the importance of strategic sourcing and how it can save millions of dollars in the public sector.2

This article will provide an overview of the rules that typically apply in public sector procurement and how those constraints affect decision making. It will then explain how managers can go about applying private sector supply chain management concepts under those constraints to achieve significant cost savings.

Public and private: how do they differ?
What makes supply chain management in the public sector different from private industry? There are a number of factors that influence supply chain practices, particularly in regard to procurement.

First and foremost is a requirement for transparency. Government transparency exists when all information is openly and freely available. In public sector procurement, this means that the procurement process, rules, and transactions must be spelled out and available to the public as well as to potential suppliers. This requirement affects such areas as advertising of the contract opportunity, the public tendering process, and the awarding of the contract. Moreover, all suppliers must be treated the same regarding access to information, specifications, and the amount of time they have to respond to a bid. Pricing is public information, and bid openings are public events where suppliers are invited to witness the opening of the sealed bid submissions.

After the lowest bid has been revealed at the bid opening, the soliciting agency determines whether the company that submitted that bid is the lowest "responsive and responsible" bidder. "Responsive" means that the bidder properly completes the bid and also answers all subsequent requests for information within stated time frames. This may include but is not limited to providing samples or completing integrity questionnaires. "Responsible" refers specifically to successfully passing the background and integrity checks that are required when the total contract price is above a particular threshold.

In addition to evaluation tools used in the private sector, such as sample reviews, reference checks, credit checks, site visits, and interviews with principals, many public agencies also conduct background checks on the company, which usually are carried out by an investigative agency such as an Inspector General's office. These investigations may also include the owners and principal executives.

Incomplete or vague responses can delay the contract award, and at any step in the evaluation the lowest bidder can be deemed "nonresponsive" or "nonresponsible." Continuing with the examples above, a vendor may be deemed "nonresponsive" if it fails to supply requested product samples within a specified time frame. Similarly, if a background check finds that a vendor has some issue in its background (for example, liens or fines levied against the company, or a conviction for corruption), the vendor may have to clear up those issues or it could be found "nonresponsible." If the vendor is deemed to be either nonresponsive or nonresponsible, then the lowest bidder will be eliminated, and the evaluation process begins again with the next-lowest bidder. Investigations add a minimum of 30 days to the procurement process, with many taking appreciably longer.

Another difference is that public procurement can be subject to the influence of multiple jurisdictions, which adds layers of complexity. For example, at the New York City Housing Authority (NYCHA) procurement is influenced by and subject to the jurisdiction of three separate government organizations. First is the U.S. Department of Housing and Urban Development (HUD), the source of most of NYCHA's funding. Second, NYCHA is chartered by New York state and thus is also influenced by state procurement regulations. Finally, the agency is subject to procurement regulations issued by New York City.

Some noneconomic factors are specific to public procurement. For example, public sector procurement professionals often must work under strict rules regarding contract negotiation. Another example: funds used to purchase material or services may have conditions attached. A recent example involved the American Recovery and Reinvestment Act (ARRA), commonly referred to as "stimulus" spending. Part of the ARRA spending requirement included a "buy American" provision; accordingly, much of what was purchased (with some exceptions) had to be sourced from within the United States. ARRA funds also had to be obligated and spent within a short window of time, which added pressure to a procurement process that already has numerous delays built into it due to the transparency requirements discussed earlier.

Public procurement professionals can utilize "preferred suppliers" that have a special status bestowed by a particular local, state, or federal government. This designation usually applies to a nonprofit organization. Many of these suppliers can only sell to other public entities, and while pricing usually is competitive, these organizations may also receive special price consideration. For example, New York state's preferred suppliers have a price differential of 15 percent, meaning that all things being equal, if the price offered by a preferred supplier is within 15 percent of that offered by the lowest responsive and responsible bidder, then the preferred supplier will receive the contract.

Under the preferred supplier system, then, the purchasing entity may end up paying a higher price. But that may be partially offset because "preferred" status exempts suppliers from background investigations and liquidity checks. This usually saves a significant amount of time, and since time has a dollar value in the procurement process, it can be advantageous.

The "backdrop" contract is another tool that is commonly used by public sector procurement professionals. "Backdrop" refers to contracts that have been pre-negotiated by another government organization or by the U.S. government's General Services Administration (GSA). Because they eliminate many of the investigative steps mentioned earlier, public sector procurement professionals often use this type of contract to speed up the procurement process. Backdrop contracts can also save money, but that is not always the case. While price-competitive, the lowest price is not assured and the possibility of further negotiation may be contractually limited.

A special type of backdrop contract is the "piggyback" contract. These are agreements between a government agency and a supplier that can be replicated by another agency with the supplier's permission. Like backdrop contracts, piggyback contracts are not subject to background checks and therefore the contracting and procurement process can take considerably less time than traditional contracts.

People's skill sets often are different in public and private sector supply chains. A recent study by McKinsey & Company and the Institute for Supply Management (ISM) showed that public sector procurement professionals "lag behind private sector companies on several performance dimensions, including efficiency of purchasing tools and processes, capabilities, and performance management."3

One reason for this disparity is that mastering supply chain management requires ongoing study. Yet many public organizations have not invested in the necessary training to keep SCM professionals up to date, forcing them to focus on what to do rather than on how to think. It is only in the last decade or so that private sector best practices have been introduced to public sector supply chain managers. However, because public organizations are under increasing pressure to reduce costs, more supply managers are now seeking outside training and knowledge that will help them to improve their operations.

Supplier diversity and environmental sustainability are major factors in public sector supply chains. The public sector, to its credit, has long encouraged the use of ethnically diverse suppliers and has long been a champion of sustainability and a major purchaser of environmentally friendly materials. As a result, the public sector is ahead of many private sector organizations in both areas.

Similarities abound
Despite the real and perceived differences, public and private supply chains are alike in three important ways:

1. They share a common goal: to obtain the best value for the organization. This means getting the most from each dollar at every step in the supply chain. In the public sector spending efficiency equals organizational efficiency; this applies not just to purchasing but to the entire supply chain.

2. Customers (and yes, the public sector does have customers) continue to demand better quality, faster service, and lower cost. If an organization cannot continuously and consistently provide materials "better, faster, and cheaper," then its long-term survival is doubtful. This is as true for public sector supply chains as it is for the private sector, especially in light of the current public backlash against the cost of government. Accordingly, public sector officials are placing a new emphasis on cycle-time compression and speeding up the supply chain, from procurement to delivery. Balancing this demand against the requirements for transparency presents a unique challenge for the public sector.

3. The new reality is that all supply chains are pressured to provide more (materials, services, information, and so forth) in an environment of continually dwindling resources. Staff reductions, unheard-of in government just a decade ago, are now commonplace and are forcing the public sector to either find new ways to provide materials and services or to eliminate some services entirely.

Another way that public and private sector supply chains are similar is that they are both subject to three trends that are driving change:

• Both supply chain models require total process visibility if they are to increase the speed of sourcing, drive down the cost of inventory, and improve the cash-to-cash cycle. Visibility promotes fact-based decision making and removes the excuses for making poor decisions by replacing anecdotes and conjecture with informational certainty. Driving costs out of private sector supply chains has been a priority for a generation of supply chain professionals. The reality for public sector supply chain managers is that they, too, need to eliminate costs from the supply chain to ensure their organizations' long-term viability.

• Both public and private sector supply chains must become more agile. In a world where continuous improvements in communication and technology lead to shorter shelf lives for many products, supply chains have the increasingly difficult job of maintaining a relevant portfolio of materials and services while avoiding the losses caused by holding obsolete material. Material liquidation is a multibillion-dollar industry that exists because of supply chain inefficiency. Agility keeps obsolescence to a minimum.

• Both types of supply chains must have transparency. The need for transparency in the private sector has become painfully apparent, as evidenced by the implementation of the Sarbanes-Oxley Act and related legislation in the United States. Transparency, however, is not just about rules, regulations, and filling out forms. It is also about ethics in business relationships. Ethics and proper decorum in business relationships allow organizations to simultaneously collaborate and be competitive. It is possible, moreover, for both public and private supply chains to have a business relationship based on trust and sharing information that rewards innovation and productivity improvement through shared savings agreements.

In some ways, then, public sector supply chains are not very different from their private sector counterparts. Public sector customers demand that materials and services be delivered with the speed and cost structure of the private sector, and public sector supply professionals are struggling with how to accomplish that. It can be done—by using private sector principles such as strategic sourcing, supplier management, and inventory control in a way that is acceptable in public sector settings. Let's take a look at those principles and some recommendations for how to successfully apply them in the public sector.

Strategic sourcing
Strategic sourcing is a series of processes within supply chain management that are focused on developing long-term sources of supply and relationships with the most appropriate suppliers so that lifetime costs are minimized. There are a number of private sector concepts and tools that public procurement professionals should consider adopting when implementing a strategic sourcing program. Some of them include:

Consolidating various buying groups under a chief supply chain officer (CSCO) or chief procurement officer (CPO). Consolidation is a very simple concept in theory yet it is one of the most difficult to implement. Through consolidation, the organization is in most cases able to leverage greater spending volumes, and it therefore gains a visibility into spending that had been unknown before.

First and foremost, consolidation will reduce the cost to procure and give the supply chain organization the opportunity to re-engineer and standardize its processes. The material and service standardization that is a key factor in reducing item cost, optimizing the supply chain, and reducing lifetime ownership costs then becomes possible. Spending consolidation also allows the organization to transition from transactional purchasing to "blanket" and "requirement" contracts that obligate funds for materials or services as needed rather than all at once, thus reducing financial risk and obsolescence.

But consolidation should not be limited to procurement opportunities. Where possible, public sector supply chains should also consider consolidating procurement with the traditional supply chain functions of distribution and transportation. This can improve supply chain management by integrating all touch points—supplier, internal, and customer—viewing them as a single unit rather than as individual silos.

Leveraging proven, cost-effective technology. The best technology for a public sector organization to adopt is one that will meet the needs of the organization not just today but also in the future, when it achieves its desired state. Technologies that public sector managers should investigate include warehouse management and advanced planning systems for managing large distribution operations; forecasting and sales and operations planning (S&OP) software; and delivery routing software for fleet deployment.

Another useful technology-based technique for procurement visibility is the "spend cube." A spend cube is a statistical analysis tool that allows simultaneous analysis of spend components along three axes: vendor, commodity, and cost center.

For example, suppose a large organization with several buying divisions wants to consolidate its purchases of information technology (IT) hardware. By utilizing spend cube technology it can identify all of its contracts for IT hardware according to buying group, supplier, and even the specific hardware purchased. Looking at history and current requests, the purchasing organization can determine whether the leverage exists to consolidate contracts and possibly bid a long-term requirements contract out to just a few suppliers or even to one.

The state of Georgia, USA, is using spend cubes to manage spending at all state government agencies as well as at the state's 35 colleges and universities. The state's cube allows for continuous updating (refreshing) rather than the common practice of creating cubes with only a one-year snapshot of information. Continuous updating allows the procurement organization to benefit from current market dynamics and the latest procurement information and not depend on a single snapshot in time. Georgia's "Spend Under Management" (SUM) program, which includes the spend cube approach, has been so successful that it won in the Technology category of the 2011 Awards for Excellence in Supply Management awarded by the Institute of Supply Management.4

Segmenting and/or rationalizing suppliers. Supplier segmentation is a savings mechanism that groups purchases made over a period of time (usually one year) by dollar value of commodity or dollar value by supplier. Information from this exercise can determine the relative importance of suppliers and the risks associated with having too many or too few suppliers for a commodity.

One important byproduct of supplier segmentation is supplier rationalization. As buying groups are consolidated and procurement organizations review their suppliers they often find that they have several contracts that include similar items and are good candidates for consolidation.

Properly structuring bid documents. Much of suppliers' behavior is determined by how the organization structures its requests for quotes (RFQs) and requests for proposals (RFPs). RFQs and RFPs must be clear and concise relative to terms and conditions, material specifications, and the procurement process itself. If the process changes, then the buyer should hold bidders' meetings to communicate these changes.

Another tool that public sector procurement professionals should use in bid evaluation is the "should cost" technique. "Should cost" pricing is derived by developing an approximation of the supplier's actual cost to produce and deliver the materials or services requested. This analysis can then be used to identify inefficiencies or opportunities for cost reductions. For example, if the transportation component of a material purchase is known, and the purchasing organization has a truck fleet, it may be more advantageous for the purchaser to pick up the material using its own trucks and claim a freight allowance in doing so.

Should-cost pricing is developed by building cost models based on both standard data and information that has been requested as part of the RFQ process. The cost models can also be used in negotiating the final contract and in negotiations that may occur if the supplier requests a price increase.

Supplier relationship management
Good supplier relationships are easy to manage, and easy-to-manage relationships cost less to maintain. Yet all too often, public sector supplier relationships seem to run the spectrum from commodity-driven to contentious. Supplier relationship management, which establishes policies that govern supplier relationships, can help change that situation.

The key to good relationships is to develop a balance between managing suppliers and being an advocate for them within your organization. Procurement professionals should manage supplier relationships through objective measurement data to determine how well the supplier is meeting the business's requirements. One of the best tools for this is the supplier scorecard. There are numerous formats to choose from, but the most effective is one that measures from three to five criteria and weighs them based on importance. Commonly used criteria include ontime delivery, completeness of delivery, and quality, among others.

Scorecards quickly improve suppliers' compliance with established performance standards—especially when the policy for utilizing the scorecards includes meeting face to face with delinquent vendors to discuss their performance. Because its scorecards give the New York City Housing Authority an objective measurement of performance, the agency can legally find suppliers "nonresponsible" if they bid on a new contract while they are rated as unacceptable on an existing contract. That, of course, provides a strong incentive for suppliers to improve.

Another factor in good supplier relations is contract length. Many public sector procurement managers prefer short contracts of one year or less because they usually are bid as fixedprice contracts. In such a case, suppliers need only concern themselves with a short-term contract for which their costs can remain relatively stable, and the purchaser believes that it is receiving the best price. (Unfortunately, the purchaser often does not consider that it costs both the supplier and the purchaser a significant amount of money to create and bid a contract, and that this cost has to be absorbed into the price. Additionally, there is a cost for the purchasing organization to manage all of these contracts.)

While there may be some logic in this, the number of contracts managed can become unwieldy. As an alternative, public procurement managers should consider lengthening contracts where possible. Longer-term contracts provide the supplier with an added level of stability and an incentive to keep prices low over time. The supply chain manager, meanwhile, will spend less time on contract development and more time on supplier relationship management. Managers should also consider including a price adjustment clause that allows prices to be revised (up or down) based on "should cost" pricing and an index such as the Producer Price Index (PPI).

Supplier relationship management is not an adversarial situation, with the supply chain manager always on one side of an issue and the supplier on the other. Instead, the public procurement professional should also be an advocate for suppliers when necessary. For example, when there are issues associated with deliverables or late payment, the manager can strengthen the relationship by helping suppliers navigate through the organization and resolve the problem.

Supplier collaboration programs, in which suppliers and purchasers exchange information for the purpose of reducing costs for both enterprises, are also excellent ways to maintain communication. Sharing information is a key to improved fill rates, customer satisfaction, and productivity.

Inventory management
Effective inventory management is another private sector best practice that can be implemented in the public sector with very positive results. Many public sector supply operations utilize a "buy and hold" strategy, where material is purchased in large quantities and held until needed. The private sector abandoned this strategy long ago when managers recognized the considerable cost of carrying inventory, including the costs of obsolescence, damage, shrinkage, taxes, and so forth. The public sector, on the other hand, has tended to ignore carrying costs. That's because funds for the purchase of inventory usually are included in annual budgets, and the organizations do not pay interest on that money.

This environment has changed drastically in the last several years. Although carrying costs remain very low, public sector organizations now consider the opportunity cost of carrying inventory. They recognize that their warehouses must turn inventory faster because every dollar tied up in inventory is no longer available for use. The most effective way to accomplish this is through a comprehensive inventory management program that makes use of the concepts of inventory visibility, inventory accuracy, inventory minimization, and warehouse optimization.

While the reasons for carrying inventory in the private and public sectors may differ, inventory management techniques need not differ greatly, although some adjustments may be required. The most important of these is inventory visibility. Visibility includes knowledge of "available to promise," allocated, intransit, and shipped inventories. It should also include knowledge of inventory levels of critical material purchased from primary suppliers. To achieve these results, inventory is best managed using robust inventory management software.

Inventory accuracy is the bridge between visibility and inventory minimization. Operational accuracy in the warehouse is paramount for effective inventory management, and cycle counting is by far the best method to achieve it. An effective cycle counting module must be part of any inventory or warehouse management system. Random audits provide a backup to cycle counting as well as the audit verification required to maintain confidence in the system and satisfy risk analysts.

Inventory minimization turns what is known about the demand patterns of an item, group, or commodity into cost savings. Inventory minimization requires knowledge of usage over time, an understanding of the material's volatility or variations in volume, and rapid replenishment by suppliers. It is best to implement an inventory minimization program in stages as risks are eliminated. This worked very well for the New York City Housing Authority. After NYCHA's Supply Chain Operations department (SCO) had its supplier scorecard in place for a year, it identified its most consistent suppliers and reduced their inventory requirements to more closely align with replenishment cycle times. As more suppliers reached an acceptable level of consistency, inventory requirements for those items were reduced in a similar manner. (See the sidebar for a list of the supply chain improvements NYCHA has achieved since 2004.)

Warehouse optimization combines various aspects of ABC analysis, slotting strategy, order planning, and picking processes. ABC analysis stratifies material movement into "A" items (fast moving), "B" items (medium speed), and "C" items (slow moving), usually through the use of Pareto analysis, where the top 20 percent of stock-keeping units (SKUs) account for 80 percent of demand. Slotting strategy then locates these groups in the most efficient warehouse locations.

Warehouse managers use ABC analysis and slotting strategy to determine SKU velocity (frequency of picks and number of items picked), and then use that information to determine the best locations for specific items in the warehouse while minimizing total travel distances. For example, the fastest moving items are given storage locations closest to receiving (to minimize putaway time) and to shipping (to minimize picking time).

Order planning refers to one or more of the many methods used to manage order handling and picking. Most order-processing plans have a picking sequence that is either fixed or dynamic. A fixed picking schedule is repeated, usually daily or weekly. Dynamic schedules change each day based on the orders that have been received. Dynamic order processing is common for catalog retailers, where each day's picking and shipping differs due to the randomness of the customer orders. NYCHA uses a fixed weekly delivery schedule. Each customer (usually a housing development storeroom) has a specific day on which its orders are picked and shipped.

Picking processes vary depending on the type of material and the volume picked. The two most common picking strategies are order-level picking and batch picking. There are numerous picking methods to choose from, including single order, multi-order, and pick and pass (a picking method similar to zone picking except the pick cart is "passed" to a picker in another zone). Each has its advantages and disadvantages and should be thoroughly reviewed to determine the best method or methods for a particular application and situation.

Two sides of the same coin
In the final analysis, it is how well these concepts work that truly determine their worth. Based on seven years of experience managing the New York City Housing Authority's supply chain, it is clear that public and private sector supply chains truly are "two sides of the same coin" and that many private sector best practices can be used in the public sector with great success and with little or no modification. By focusing on three areas—strategic sourcing, supplier relationship management, and inventory management— public sector supply chains can make order-ofmagnitude improvements, generate real savings, and create even more supply chain successes.

Endnotes:
1. Christian Husted and Nicolas Reinecke, "Improving Public Sector Purchasing," McKinsey & Company (2009).
2. David Yarkin, "Saving States the Sam's Club Way," The New York Times, March 2, 2011.
3. Husted and Reinecke (2009).
4. Lisa Arnseth, "Smart Procurement on Georgia's Mind," Inside Supply Management, April 2011.

Gary A. Smith, CPIM, CSCP, CPSM, is director of supply chain operations for the New York City Housing Authority.

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