Moderator

Mar 092020
 

Hello again cost management aficionados!

I would like to announce the first in my series of deep dive profiles on specific product cost management software solutions. You all may remember that I did a two-part series on the history and landscape of PCM and Spend Analytics solutions with our good friends over at SpendMatters.com in December. You can find those jumping off point analysis here and here.

As of late last week, we posted the first of our deep dives on one of the solutions, What’s the Price (WTP).  Please check it out over at Spend Matters. One caveat: I have been the victim of my own success in that Spend Matters thinks the article such good content that you will see a teaser article and then need to pass through their paywall to see the full analysis.

WTP is really intriguing as a software solution, so I hope you enjoy the analysis!

Here’s a teaser of some of the insight that you’ll get:

Click here to read more!

Eric A. Hiller

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Feb 032020
 

Summary for Lyft CEO

Ride-hail is not going away, but it must to get profitable.   You can try to “grow to profitability”, but as was have learned in the past, that is a risky proposition.

Uber is expanding, but it is already bigger than Lyft.   Is that strategy profitable, and if it is, is there enough room for two players in it.  Simultaneously, the path to profitability is getting harder with cities pushing back on Lyft and Uber, and as Lyft and Uber attract new customers, they may be less profitable riders.   Consider another option:  an alternative targeted and differentiated strategy:

  • Lyft should double-down on a long-term strategy of letting Uber attempt to own the market… but in reality, building the interstate for Lyft to toll
  • Continue to build cultural allegiance driver, rider, and city — which will differentiate and win in a commodity market in the longer-term, as Lyft captures share in an increasingly regulated environment
  • Follow to profitable geographies
  • Long term invest in autonomous public transport, leveraging massive experience with app / software and routing vehicles to individuals

Ride-hail – an establish Wall Street darling, dominated by two players

If you live in a city of any size over 50,000, it’s likely you have access to or ridden with a ride share / ride-hail firm — a firm that uses the vehicles of private people (being driven by those people) to synthesize a taxi-cab company. I certainly have used them extensively in business travel, and some for personal trips, too.

These services have changed the way that people experience big cities, and serve many important use cases, such as the following:

  • Much less expensive alternative to a cab for those already using cabs, if you are concerned about money.
  • Often a more pleasant experience than a taxi cab, even if someone else is paying for the ride (e.g. business travel)
  • A not-that-much-more expensive option to public transportation (as public trans gets worse in many cities).  This has been advance even further with the shared ride options on these apps
  • A safe option for people (especially women) going home at night, in lieu of walking or public transportation
  • Another excellent option to protect the public by giving another alternative to drunk driving
  • A way of reducing parking fees, and sometimes even needing a car at all for consumers
  • A method to take the load off of limited (and expensive) urban parking for municipalities
  • In some cases, reduction in traffic
  • etc.

The 800 pound gorilla that rules the space is Uber, but there is a wiry and strong orangutan in the asphalt jungle as well: Lyft.

Today, we want to look at the Ride-hail market from both an industry perspective, but also from the standpoint of the Lyft CEO.

Ride-hail is a growing market, with broad customer appeal

As of July 2019, the ride-share market had grown to $184 billion (See Figure 1).  This is predicted to grow, but with a diminishing year-over-year percentages of growth.  The amazing thing is how much the US market is truly a duopoly, and it is getting even more so.  In 2019, only 1% percent of revenue was from other companies, down from 4% just two years before.

Figure 1 – click to enlarge!

Figure 2 – click to enlarge!

Looking at Figure 3, we can better understand the customers of the Ride-hail revolution.   Not surprisingly, the users are predicted to go up handsomely through through 2023, although revenue per user does not seem to go up by a lot.  For example, from $184 in 2019 to $208 in 2023, that seems like it could only be 1-3 extra rides per user (and how much of that would be inflation)?

Figure 3 – click to enlarge!

Figure 3 also shows us WHO the users are.   Not surprisingly, younger people are using Lyft and Uber more than older people.  That is to be expected for a couple of reasons:

  1. Younger people tend to be more comfortable with technology and new ecosystems
  2. Younger people tend to live in urban areas, whereas there is a general trend when one gets older and is married (and especially with children) to move out to the ‘burbs or even more rural areas, where traffic is lighter and parking is plentiful, easy, and cheap.

However, the age demographic trend probably goes beyond this.  The Wall Street Journal in 2019 noted a shocking fact that:

“about a quarter of 16-year-olds had a driver’s license in 2017, a sharp decline from nearly half in 1983”

Whoa… as someone who grew up in a rural area, this is shocking.  Everyone I can remember in my high school viewed driving through the same lens:  driving was cool; driving was a rite of passage to adulthood; driving was independence; driving was all American; driving was… personal freedom!  However, the WSJ article does not shock me, because I have heard several people tell me about their kids or grandkids who have no interest in driving.  If that is the case, then one would think that these as Zoomers become older, that average revenue per user would skyrocket (i.e. it’s pretty difficult to accomplish your transportation needs on $208, or even 2-3x that per year).

Interestingly, men use Ride-hail more than women.  That was very counter-intuitive to me, but maybe that is because this is worldwide data, not only US.  On average, the guys I observe in the US are cheaper than the girls (e.g. more likely to drive their own car and look for cheap parking rather than pay for a ride).  And, one would think safety would be a greater concern for women in general (or they are more reasonably aware that it should be a concern than for some men).  However, this probably means that there is good market growth potential as women’s share of usage increases, maybe past men’s.

However, the most encouraging demographic slice if you are the Lyft or Uber CEO is that the service seems to have broad appeal to all income levels.  While it does skew to the high income earners, medium, and low income earners also have a substantial slice of the pie.  Note though that it is probably not as “egalitarian” as it looks, depending on how these classes are defined.  For example, if the high income group is 10% of the population then the revenue per user is much higher for people in the high income groups than that of the middle or low income groups.

But, Lyft and Uber’s thirst for growth makes it hard for investors to believe their claims of near-term profitability

Figure 4 – click to enlarge!

This all looks great, right?   Well maybe, but this ride could also be more of a Delorean, taking us Back to the Future… back to about 2001.  Remember, the “Internet Bubble” and its bursting?   If we look at Figure 4, we see that while growth is very good on Figure 1 and 3, these are FAR from profitable companies, despite their IPO glamor.

While Uber seems to be doing better than Lyft on Operating margin, Operational Net Margin, and EBITDA Margin both are extremely negative.  However, when Lyft calculates their version of adjusted EBITDA, they claim that it was only -45% in the 3 months ended September 2018 and now is a mere -13.4% for the 3 months ended September 2019.     You can see how Lyft gets to its number on Figure 4, which shows it’s adjusted EBITDA calculation.    Lyft claimed in October 2019 it would be adjusted EBITDA positive by end of Q4 2021.  Uber is doing worse (-15% adjusted adjusted EBITDA margin) per their own EBITDA numbers for Q3 2019, although it is interesting to see how it breaks out by business line.  The core business of rides does have positive EBITDA, but all the other business lines are in the red.

So, why doesn’t Uber just divest these unprofitable new ventures (or at least quit dumping so much fuel into their tanks).   Some believe, it is the insatiable need for growth to stave off investor confidence loss and the bursting of the next potential bubble.

Figure 5 – click to enlarge!

Figure 6 – click to enlarge!

There is a concern that the most lucrative markets are becoming saturated and that municipalities are about to strike back

There is some potential worry over global revenue by country (Figure 7).  It’s amazing that 91% of the ride-hail revenue is from only three countries and 97% from five.  On one hand that seems like an opportunity for Lyft and Uber.  I.E. can’t they reap massive growth by opening up LATAM and the EU?    Maybe, but there are concerns:

  • Opening up new countries requires expensive fixed cost investments to be made
  • Just like secondary locations for a franchise, the “B and C” tend to be more expensive / less profitable than the A sites.
  • Different geographies can bring different competitive threats.  For example in the EU, competitors are focused on profit and efficiency more than the US Silicon Valley heavy-weights.

Figure 7 – click to enlarge!

In other markets, saturation could become a limiter.  For example, in the Ride-hail markets biggest geography (China) the market is already 36% saturated.  Granted, it is controlled 90% by Didi, which Uber partially owns.  But, the question on my mind remains: is the other 64% of the market (a) real and (b) able to be served at reasonable profitability?  Supply and demand tells us that profitability will suffer as ride-share penetration goes up.

In the US, it would appear that ride share penetration has a lot of room in the trunk still.   It is only 22% penetrated on average, per Figure 7.  And according to certify.com, many large cities have lots of share left to take.  However, one wonders how long Uber and Lyft can go before suffering more profit and demand-damaging actions from cities.  For example:

  • California is trying to bend Lyft and Uber to their will by forcing drivers to be treated as employees, not independent contractors.
  • Chicago’s mayor just tripled taxes on Lyft and Uber for downtown rides and raised them elsewhere.
  • Many cities are upset, because they believe Lyft and Uber are causing more traffic and congestion, not relieving it.  As rides get cheaper, more people, they believe, are being wooed away from public transport.  And, as anyone who lives in a major US city knows, public transport is already rarely profitable, and often a quite unpleasant experience.

There are big differences in Uber and Lyft, not apparent to outsiders on first glance

Figure 8 – click to enlarge!

So, what do you do if you are Lyft’s CEO?  To answer that question, we should go beyond the financial numbers only, to more fundamental differences.  Figure 8 shows us some operational data.   Uber has a much more massive international footprint and is expanding into lots of revenue streams.    If Uber and Lyft are both about “get big fast,” Uber wants to be the BIGGEST and the fastest.  That shows in its driving metric of number of users on its platform.  On the other hand Lyft seems much more concerned about profitability (for themselves and their drivers).  Although, from previous figures, we can see their own concepts of adjusted EBITDA do not really vary much in the end result.   This should give us a clue to a hypothesis, i.e. maybe Lyft should focus on being efficiently fast drivers, not reckless speed demons, as Uber seems to like?

Figure 9 – click to enlarge!

To confirm investigate further, let us take a look at a cultural snapshot of these companies (Figure 9).  I always like to say, “Everything has a genesis from people to software.”   That genesis typically has long lasting and inherent influence on who we grow up to be and how we grow up to be.  Uber spawned from the idea of improving black car service; Lyft was was more personal and folksy, about public transit and car-pooling.   This helped forge each company’s values.  Lyft is “your friend with a car,” where Uber is more the slick velvet rope service, without a VIP price.

SOURCES for Figures 8 & 9:

A common complaint in both companies cultures, but that seems worse in Uber’s, is the feeling that most drivers have that the compensation they make is very murky.  It is not transparent to the driver and, especially on Uber, it seems to be constantly changing.  This gives Ride-hail compensation the gestalt of a shell game or a pyramid scheme sales contest.   In fact, many drivers are getting an MBA from the school of hard knocks in the difference between cash flow (which they see) and profit (which they are uncertain they are making).

To [over?]abstract and synthesize these two competitors (which can look identical to many users, investors, and casual observers), we could put Lyft and Uber on a a trusty 2×2 matrix (Figure 10).  The axes would be the financial strategy to win vs. the cultural strategy to win.   NOTE: on this 2×2 matrix which quadrant in which a competitor resides is only strategically positional.  It does not imply better or worse (e.g. top-right quadrant is not necessarily better.).

Figure 10 – click to enlarge!

Uber started off at the top right, which is:

  • Financial strategy: Get big, fast / 1st mover (geographic scale and platform breadth)
  • Cultural strategy:
    • For rider: reliability, formality, hospitality
    • For driver: provide the volume of riders

On the other hand, Lyft is in the opposing corner:

  • Financial strategy:  More steady & safe risk valuation growth (higher rev. / rider, fast follower to Uber)
  • Cultural strategy:
    • For rider: authenticity, fun, ethics
    • For driver: transparency, higher-profit rides

However, Uber struggled at the end of the founding CEO’s tenure with some alleged internal cultural challenges that eventually led to a CEO change.    The new CEO seems to have nudged Uber’s cultural position in the direction of Lyft.  However, how much of this was reactionary vs. strategic is unknown.

Looking at the service itself, Ride-hail is mostly a commodity at the end of the day.  In a commodity, market, who ever has the lowest price, wins.  Often, having a lower price is dependent on scale, because then overheads can be amortized more efficiently.   Uber is ALREADY much bigger than Lyft, even in the US alone.  Therefore, it is a risky / unlikely proposition that Lyft can overtake Uber to be the low-cost producer in a commoditized market.

Lyft needs to structure its go-to-market on it own terms as a differentiated and city/driver-friendly player, letting Uber be the commodity business and high-end player

Lyft needs to DE-COMMODITIZE the market by leveraging its natural cultural strengths and accumulated good will with drivers and riders.  There are 3 stakeholders (outside of Wall Street) it needs to win:

  1. Drivers
  2. Riders
  3. Municipalities

Figure 11 has recommendations for each of those areas.  Long term, it is likely there will be less need for drivers, if autonomous vehicles do finally become technologically and financially feasible.  However, many think that is 10-20 years away, and until that happens, why not have drivers who want to take your rides first, before accepting Uber’s?  Uber may still have the volume, but Lyft is continuing to grow that.   Lyft needs to give drivers more and simpler choices.  For example, they could offer drivers who prefer more steady income a more set salary, while allowing others to take more reward with risk.  Either way, the driver needs to feel that he (/she) is in control and certain of how much he’s making on the fare.  In fact, the Lyft’s driver app team needs to work very hard to offer the driver simple to use graphical tools on the driver app to intelligently make that decision.

Figure 11 – click to enlarge!

Happy and more loyal drivers can help with the other two constituencies, especially municipalities.  Ride-hail drivers are not the wealthy.  Lyft needs to educate municipalities that a good number of these drivers are lower income, and if not for Lyft, they could not afford their own vehicle and/or would be using more city resources for the poor. That would play especially well with more socialist regimes like California and Chicago, who are the vanguard that is harrying Lyft and Uber

Lyft should also should be partnering with cities where Lyft can do the city cannot.   The big difference between Ride-hail and public trans, is that public trans has a set course, where ride-hail is on demand and creates custom routes.    But, there are positions in between on this spectrum.  For example, Lyft could allow enterprising drivers to buy or lease mini-buses, custom designed for rapid ingress / egress (e.g. every row has a door on each side and there are 3-5 rows with easy to maintain but study individual seats).   These buses could be Geo-fenced to areas with high densities of riders.  Think of the possible advantages for the stakeholders:

  • Rider, gets to stay inside in the warmth (winter) or cool (summer) until the mini-bus arrives (same as ride-hail).  Compare to the frigid experience at a Chicago El or bus stop!
  • Rider pays less, becuase the mini-bus or ride-hail van is a logical extension of the shared ride idea that Lyft Line uses already
  • Cities like it, because every ride-hail van takes 3-4 individual cars off the road, reducing traffic and the need for parking
  • Cities like it, because it helps the environment.  These ride-hail vans could even be electric, charging in the bus lanes if there are already tram cables and / or with fast swap batteries that are replaced at a few swap stations around the Geo-fenced areas, while the driver takes a break, eats, etc.
  • Cities can use it for multi-modal travel.  At the end of the night, if someone lives outside the mini-bus radius, the bus can drop them of at a charging station with a warm and safe waiting room to be picked up by an individual Lyft to complete the trip home (coordinated to arrive, at the same time the mini-bus does).  These charging / transfer stations could also be located close to subway or buss stops in various directions.
  • Cities could be convinced by Lyft that this is “hybrid-public” transportation and tax it, but in return, all the ride-hail mini-buses get to use bus lanes and other priority traffic mechanisms
  • Driver makes less per rider, but is getting many more riders per hour, because the pick-ups and drop-offs are very close to one another and fast, due to the design of the vehicle.
  • Driver spends less time in traffic and waiting for the next ride and more time with paying passengers.

What is the barrier to entry?  Only someone with the experience and technology of a Lyft and Uber has the tech ecosystem (app for drivers, servers to plot routes, past learning, network of drivers, etc.) to make this work.   Individual cities can’t do this themselves, but they could using Lyft’s technology.  Alternatively, they could pay a SAAS subscription or revenue royalty to use the Lyft tech platform and staff it with their own public trans employers and owned ride-hail vans.  There are many options, but this would be a “sticky” partnership, i.e. once a city sets this up with Lyft, they would have a lot of natural disincentives to stop the relationship.  For example, hundreds of their citizens would be employed in this Lyft/city ecosystem and tens of thousands would be happy users of the network.   Is a mayor up for re-election going to mess with that?  In fact, instead of cities fighting to keep Lyft out, or Lyft waiting for the 800 pound Uber to kick down the door into a new city, new cities may invite Lyft in to start such a partnership.

The last stakeholder is the rider.  We have discussed some benefits to the rider already.  Lyft may be ceding some of the high income / business class to Uber in this strategy, but maybe not.  Given the younger demographics of ride-hail, Lyft can leverage its car-pool / environmental / fun image to younger riders.  As they age and get promoted in their jobs, they likely will have loyalty to the Lyft brand, when they graduate to the more expensive and exclusive private ride-hail vehicles.

In traditional private car ride-hail, lyft should double-down on a long-term strategy of letting Uber attempt to kick down the doors first and then come into the market after it is proven possible and profitable.

Conclusion

Ride-hail is here to stay.  Literally millions of riding customers would be angry, if it stopped.   But, it has to get profitable.  Uber is 150% wed to its get-big-fast and become a travel and freight conglomerate strategy.   The questions are:  is that strategy profitable, and if it is, is there enough room for two players in it.  Both are murky questions, but there are other, less risky options for Lyft to pursue.  Simultaneously, the path to profitability is getting harder with cities pushing back on the ride-hail players and the ride-hail players likely suffering less profitable riders as they penetrate the market and his supply / demand constraints.  If Lyft pursues an alternative targeted and differentiated strategy, it can re-route around the jammed-up main traffic arteries on which Uber and it are currently driving together, and take a short cut to a profitable and sustainable destination.

=======================

Eric Arno Hiller is the managing partner of Hiller Associates, the leading consulting firm specializing in Product Cost Management (PCM), should-cost, design-to-value and software product management.   He is a former McKinsey & Company engagement manager and operations expert. Before McKinsey, Mr. Hiller was the co-founder and founding CEO of two high technology start-ups: aPriori (a PCM software platform) and TADA.today.   Before aPriori & TADA, he worked in product development and manufacturing at Ford Motor Co., John Deere, and Procter & Gamble.  Mr. Hiller is the author of the PCM blog ProductProfitAndRisk.com.    He holds an MBA from the Harvard Business School and a master’s and bachelor’s degree in mechanical engineering from the University of Illinois Urbana-Champaign.

 

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Jan 222020
 

As a consultant, I am sadly, no stranger to extensive travel, and the inevitable hassles and pains that come with it.  Nor, as a resident 24 years in Central Illinois, 10 in Boston, 5 in Detroit, and 6 in Chicago, am I a novice to how to handle bitter winter conditions.  However, recently, my wife and I shared such a bad travel experience with 4,000-5,000 other people that it compelled me to not only rage about it while it was happening, but to reflect more deeply upon it as an ops and process improvement professional.

In this article, I will not only take you through horrible travel experience, but also look at it from a critical ops professional point of view.  Hopefully, Hiller Associates can not only provide some advice to a foreign airline and airport, but that we all can consider in designing and building organizations to be fault tolerant and resilient to surges and shocks.

The Narrative

My wife and I were returning from Europe to the US several weeks ago, after succumbing to this newish first-world fad, a “babymoon”.   It had been a whirlwind of education in history, culture, religion, art etc. in the winter in Paris, Belgium, and the Netherlands – even combined with a business meeting (who says multitasking doesn’t work?).    After our last three nights, in Belgium, where an old friend kindly hosted us in his home with his family, we were flying out of Brussels.  Always cost conscious, I had our flight going from Brussels (BRU) to Keflavik (KEF, Iceland) back to Chicago (ORD) on Icelandair (IA), which seemed to be saving a fair amount vs. other options. 

Enter winter weather, which is to be expected in January, and was a massive shock to the system (in this case Keflavik airport and Iceland Air).  As we will see, such shocks are sometimes unavoidable, but what matters is how you have (1) prepared for and (2) react to that surge / shock condition.

Feel free to follow along with what I am about to tell you with a birds-eye process flow view using Figure 1.

Click picture to enlarge!

We started spending 4-5 hours comfortably seated in Brussels airport, as we received furious texts and emails from Iceland Air delaying the flight, repeatedly.  However, I do not remember getting any notification that a voucher for food was available, until I talked to a nice Belgium employee of Iceland air… 30 minutes before we had to board.  Unfortunately, Iceland Air was being frustratingly obtuse on whether our connection to Chicago would be waiting when we landed for several hours, or not.  We were supposed to leave at 1 pm CET from Brussels. It was now 5:00 pm.

Three and a half hours later, we were circling Keflavik, and that is when the problems got much worse.  We ended up circling for 15-30 minutes.  We had to complement the pilot for getting us down safely, as it may not have been a safe idea to have let us take off in the first place, given the winds and blizzard conditions.   Iceland claims it is warmer than NYC in the winter, but the conditions were very bad this night.

We’re there!  Wrong.  We were about a football field from the airport… but we have to wait for over 2 hours.  Eventually Iceland Air (who does NOT serve meals on international flights unless one [over]pays) gives everyone a little water and a sad granola bar.  This is a place is called ICEland, but they seem to have no plows to clear a path to the runway, and for some reason, we cannot just creep slowly for a few minutes through the snow.  When we finally do taxi to the airport, there is not even a jetway.  We have to exit down an icy set of stairs, out into the blizzard, then carry bags upstairs to the airport.  We thought to ourselves, “couldn’t we have just walked the football field 2-3 hours ago?”  My hopes of making the connection are now dashed, but at least the ordeal is over, right?  Wrong.

~10:00 pm UK time – upon entering the airport, my recovering engineer and process geek spidey-senses were going off immediately.  The scene had a refugee camp malaise and chaos to it, with people looking utterly confused (including Iceland Air employees).  We were eventually funneled into a long line of passengers from multiple flights waiting to speak with only two people from Iceland Air to help us figure out what was going on. In the US, I would have called the airline, but it was clear that strategy would be futile with this national carrier.   I send my 7 months pregnant wife out for food immediately, fearing the worst, as I held position.  She returned 10-15 minutes later shocked that there is only one market / newstand open for food.  She reported the sort of scene I remember from 60 Minutes segments in the 80’s, inside a supermarket in the USSR, as frantic passengers swarming like locusts over rapidly emptying shelves with not nearly enough food and drink.  She spent over $40 for two sandwiches, a couple bags of potato chips, a water, and a strange chia seed fruit dessert cup thing.  The only protein my wife can find in the middle of the night is cold deli meat on the sandwiches, which she is nervous to eat, being pregnant.   We fuel up for what is going to be bad night.   

After making friends with people in line, and waiting for almost 2 hours, suddenly everyone in our line and the entire airport is told to get their luggage.  But, it’s unclear to everyone what to do?  Wait in line?  Go to baggage?  Given the cycle time of Iceland air to  help each person seems to be 10-15 minutes, I decide this was sunk cost, and we headed to baggage.  However, the airport had now sent several thousand people through a very small pipe (one escalator) at once.  It took half an hour to move several hundred feet.  Getting the luggage was not that bad, considering, but then we were directed to ANOTHER line.  At least this time there were about 6 Iceland Air desks open.  However, there were 2-3 times that amount that COULD have been open.  Why are they closed?   My wife, who is pretty low-maintenance and much more patient than I am, beseeches the Iceland Air lady who is herding us.  She says she’s pregnant and we need something more than the airport floor tonight.  The women shrugs, and it is clear that she could not care less.   After 2 more hours of miserable standing, they announce there are no more hotels (at least in Keflavik). 

While waiting we noticed an army of heavily geared-up search and rescue guys, looking like they wanted to help around the airport, but not being used in the least.  The airport also announced that the Iceland Red Cross was setting up a “shelter” with some water and cots, because there are no hotels.  It’s now 1 am.   Children are asleep on suitcases; the disabled are dozing in wheelchairs.  One lady passenger kindly offers us a blanket she stole from the plane.  My wife, typically a trouper, is done; she bursts into tears.  I am out of patience, too. I’ve been noticing failure after failure in the operations of this place, and I am professionally and personally offended. 

Hailing a search and rescue guy, I explain the situation.  He is the only person in the airport we have met that is (a) empathic and (b) had an action bias.  He says not to worry and he’s on it.  After 15-20 more minutes, we do have vouchers to a hotel in Reykjavik (it is 45 minutes by car, but at least my wife is not riding on a donkey while I seek a stable and manger).   But then we find out that apparently there was an accident on the road and other plowing problems for which they were unprepared (in a country called ICEland).   Busses are delayed; cabs are delayed; it is 2 in the morning.   A group of 10 of us have to wait about 30 minutes outside in the blizzard, as one cab arrives every 5 minutes.  Finally, we get a very nice driver who speedily spirits us away to the hotel.

The next morning (after a good hotel and breakfast), we feel a little better, but things are not better at the airport.  It takes 4x the time it should to check-in, because Icelandair’s one kiosks and systems are confused that we have all been transferred to new fights, so the system forces everyone to the human desks (now 12 are open thankfully).  After more lines at security, we go to the gate, which is chaos as well.  There is no seating, and people are jammed up in the hall blocking other people who are trying to get through, while other passengers pack themselves on the stairs from our level up to the jetway, creating a fire hazard on the stairs.  No one from the airport or Iceland Air takes charge to get the people off the stairs and have them line up in an orderly fashion along the hallway wall (I regret that I did not show the initiative to do so, myself). 

But, eventually we do board and, mostly, uneventfully get home to Chicago.

What went wrong and how to improve the operational system

So, that is the story.  It could have been a lot worse, i.e. as far as I know, no one was serious hurt in the ordeal, but the suffering of thousands of passengers (and many airport and Iceland Air employees) in that airport that night was clear.   The weather was so severe it was unlikely that most people would have ever gotten out that night, but the experience could have been much better, if things were handled differently. 

Figure 2 shows the various critical elements of an organization (Culture, Strategy, Process, Team, and Tools / Infrastructure), as well as KEF’s assets, some of the failures that we observed, and ways these failures could have been eliminated, or at least, significantly mitigated.

While we go through this, keep in your minds that iconic scene in Apollo 13, where ingenious NASA engineers look at the problem from the standpoint of what they DO have to work with, dumping out a box of miscellaneous items that are on the spacecraft.  I don’t know all the assets that KEF and IA had; it is probably far greater than what I observe here, but we did observe some powerful tools that could have been leverage much more.

Click picture to enlarge!

Culture

Let’s start with culture, because as a famous quote probably mis-attributed to Peter Drucker said, “Organizational culture eats strategy for breakfast, lunch and dinner so don’t leave it unattended.”  The first thing that was apparent to me was there seemed to be a lack of strong and directive leadership.   Different styles of leadership tend to work better or worse depending on the situation, but in a crisis, somebody needs to be in charge.   Perhaps this was influenced by culture.  For example, according to Wikipedia, “… an important key to understanding Icelanders and their culture… is the high importance they place on the traits of independence and self-sufficiency. In the June 2005 European Commission Eurobarometer public opinion analysis, over 85% of Icelanders found independence to be “very important” contrasted with the EU25 average of 53%, 47% for the Norwegians, and 49% for the Danish.”  Some of the other Americans at KEF were telling us this similar observation about Iceland after having spent a couple weeks there, as well.  Often our greatest strength is also a weakness at times.  The lack of leadership caused a palpable uncertainty that we could feel from the small things (no one telling us to get out of the middle hallway at our boarding gate and line up along the wall) to the process (no one was parsing passengers into needs-based groups that could be handled en masse) to the holistic (KEF and IA seemed to be using the same processes they would use for a normal load scenario in this surge scenario). 

No leader seemed to be stepping up and saying, “Stop!  This is not working.  Let’s do this instead…” (and deploying resources accordingly).   Even the visible presence of an executive leader (maybe even dressed differently to show their rank) walking around the airport controlling things would have given certainty to passengers.  We recommend that KEF and IA work on a command structure with clear roles and authority for the future.  One asset that could likely help is Iceland’s tight-knit, homogenous population.  They only have ~360,000 people (the capital is about half of that).  It is much easier to mobilize and impact with a small and ideologically-aligned group (e.g. the Navy Seals) than a lumbering mass of people.   So, KEF should have taken advantage of this (as we were told they did after 9/11 when planes were grounded).

Strategy

The second major area to improve is Strategy.  The short-term strategic failure was allowing so many flights to take off, knowing that (a) there was a high probability no connections could leave and (b) the airport did not have the capacity to handle the mass of passenger who would be stranded.  This strategic error caused the crisis.   Considering the expected low volume of the passengers who could fly out (likely none that day), KEF should have grounded / delay all incoming flights beyond the capacity of KEF to house efficiently.  These passengers could have been housed at their origin airports, spreading the load.  We understand that often you want to get people “part way home” at least, but there is a limit.

The long-term strategic error was not building surge capacity to begin with.  I am not sure KEF and IA even were aware of what the max capacity was (or maybe they severely overestimated it?).    KEF and IA needed to have tight understanding of capacity and a surge / crisis plan, beyond a Red Cross shelter.

Process

Process was a big problem in the airport.  There were many problems I observed, but let us focus on three that caused a lot of problems.  First, KEF and IA seemed to make no attempt to parse the passengers into needs-based groups, such as:

  • Special needs passengers with small children, pregnant women, the elderly, the disabled, who needed special care and more immediate attention
  • Passengers who have been re-booked already and only need a hotel and food for the night
  • Passenger who need to be re-booked
  • Sub-groups that are going out early in the day vs. late.
  • etc.

If they had, they could have directed them into different lines where each like group could be handled en masse with much faster cycle times.  And, special cases could be handled appropriately with more time and care (Lane Strategy).

There also seemed to be little preparation for this.  Clearly, it took several hours to fly to KEF and almost double that time to get to the gate.  IA could have prepared transport strategy, vouchers, bags of food to tie people over until the hotel, etc.   This would have given comfort and certainty to the passengers and greatly sped up the process for the IA and KEF team.

The team also seemed unaware of what the capacity of hotels was, given that they had only gotten through half the final queue we were in, when they announced the KEF area hotels were full.  There should have been a process to know the capacity of hotels in KEF, Reykjavik, etc.

Team

It was clear that the team was severely understaffed.  Hearkening back to Culture (leadership) and Strategy (building capacity), IA should have activated more resources to handle the crush of passengers.   And, not all jobs require the same skill.  KEF and IA could have built surge / temporary resources that have a basic level of training.  These auxiliaries would allow the full-time employees to focus on the more sophisticated tasks.  Here KEF had a big asset that was underutilized:  The Red Cross / EMS.  If I get lost in the wild, Iceland might not be a bad place to be, because it’s clear that Iceland had created a small army of EMS, loaded for bear (maybe literally?).  They were geared up and all over the airport baggage, and ticketing, looking eager to help.   But… no one was using them (except me — they were our saviors that night).   Clearly, emergency care is their primary vocation, but in these situations, it’s likely there will be few traditional medical emergencies.  A large number of the EMS folks could have been cross-trained to be auxiliaries for KEF and the airlines, hopefully with generous donations or direct payment to support the EMS organizations.

One note on training of the team: my wife’s experience with the IA employee was really poor, in that she did not seem to recognize or care that my wife was very pregnant and had been trapped at KEF for over 6 hours.  I hope IA invests in some been training with an eye to customer service.

Tools & Infrastructure

Often companies and other organizations make the mistake of thinking that more or fancier tools can cure deficient culture, strategy, process, and team.  They cannot.  Tools and infrastructure are only force multipliers and enablers of culture, strategy, process, and team.  However, the converse is not true.  If you don’t have enough of them, it can frustrate the good progress you make in culture, strategy, process, and team.   In KEF that night, this was clearly the case. 

Let us begin with the lack of food options for thousand of people and the fact the food was so expensive.   KEF and the airlines should have had agreements with the restaurants for emergency catering. It would have been easy to have tables of free or inexpensive fruit, water, juice, snacks, etc. Alternatively, lunch bags could have been hastily prepared for people to grab or handed out after they had been parsed into needs-based groups.  (EMS or other auxiliaries could have set all this up).     

The seating situation was terrible.  There was not enough seating within security and virtually none outside of it.  People were standing, literally, for hours.   KEF had an asset here:  it was a fairly large airport.   Foldable chairs could have been set up by EMS / auxiliaries.  This would have worked well in conjunction with dividing people into needs-based groups.  People could get their luggage and sit comfortably with their sorted group while they waited for attention.  For example, the airport team could have call 10-20 people at a time to go to an agent to help them, or they could address a block of 20-50 seats at a time with instructions, vouchers, etc.

The cab queue being outdoors in a blizzard was ridiculous.  However, many winter airports in the US (e.g. O’hare) also have this problem.  However, KEF had an asset here – cabs could drive right up to the terminal.  Once again, some simple blocks of folding chairs would have allowed exhausted passengers to sit comfortably in the warmth and the cabbies could come get people in order as they arrived.   Once again, parsing people by groups would have helped as well.  If people were parsed by hotel area, buses, vans, and cars could have been efficiently filled.  For example, my wife and I were the only people in a very nice 8 passenger van (75% of capacity was wasted). 

We were told that there were problems both with getting a path plowed from tarmac to airport and on the roads to the cities of Keflavik and Reykjavik.  This seemed bizarre in a place called ICEland.  This was extreme weather, apparently for Iceland, but once again there was no surge capacity in the system.  KEF and airlines could work with city and state to subsidize more equipment that the airport could acces for use inside the airport and on the arteries to it.

Finally, we have a sad tale of woe about an excellent asset underutilized when it was needed.  Iceland Air had a very good automatic text and email system for updates.  This could have been used to pre-sort people into needs-based groups and communicate instructions.  Imagine this survey:

Hi! Welcome to Keflavik airport.  Regrettably, we are having bad weather tonight, but we’ll keep you warm and fed while we sort it out.  To help us do that, please answer the following questions:

  1. Are you or are you traveling with someone with special needs (with small children, pregnant, disabled, elderly, etc.) [Eric:  Yes!]
  2. Sadly, all the connections to your destination for tonight have left or were canceled. According to our system, you have been re-booked on IA flight XYZ to Chicago (ORD) at #:## tomorrow.  Does that sound right?  [Eric:  Yes!]
  3. We have the following options for you for accommodations. Which would you prefer?:
    1. Stay in the airport (we’ll give you blankets and pillows and food – no bathing options available).
    2. Stay on cots in our nearby Red Cross shelter (we’ll give you blankets and pillows and food – no bathing options available).
    3. Stay in a hotel that we will provide (we cannot guarantee whether this will be in Keflavik which is 15 minutes away or Reykjavik which is 45 minutes, but we will provide transport)[Eric: C, please!]

Thanks!  When you arrive in the terminal:

  1. Please go to gate X, where we’ll give you some food and drink to go.
  2. Then proceed to baggage claim and collect your bags.
  3. Once you have your luggage, please proceed to the XYZ area (follow the signs), where we will give you vouchers and further instructions.

If you have any questions, please see the personal dressed in XYZ uniform. Thanks!

The other tech failure was the next morning in the check-in system.  Although we had received our boarding passes the night before, we had to re-check bags.  However, the system was not designed to handle this common exception case, so we (and everyone else) were sent to live desks of people to check bags.  This idled ~25 very expensive looking kiosks that could have reduced the load on the desks by 50-80%. 

A vision for the future

Looking at Figure 3 & 4, you can see designs of how the system COULD have worked to make a much smoother experience that would also increase throughput and capacity of the system.  It would also result in much higher customer satisfaction, and maybe even the same or less cost.

Click picture to enlarge!

Click picture to enlarge!

In the grand scheme of our lives, this was a minor hiccup, but a very painful one for everyone stuck in it for 8-10 hours.  Our thanks to the team at Keflavik airport and Icelandair who did keep us safe, and eventually put us on a plane home.   Hopefully, they will find this operational analysis useful in the future.

And, hopefully, this little case study is also something to ponder for your own organization.  Do you know what your maximum capacity is? Do you know where your bottle-necks are? Do you have a plan for surge and shock to your systems? Do you need to build capacity?   All good things to conside.

p.s. If you like nature (or Bjork), I hear Iceland is a lovely place to visit!

 

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Dec 192019
 

Yesterday, we announced the first of 2 new articles in SpendMatters.com!   They discussed the histor, and growth of the market of Product Cost Management software and the state of the art today. 

Normally, Eric would have made us hold of to tease you on part 2, owing to his steely Krampus and Grinch-like heart.  But, being that we are so deep in Advent and close to Christmas, we’ve decided to give you an early present!

Here’s a teaser of Part 2: (but, if you’re just impatient, click here)

 


In our first article in this series looked at product cost management software and how it fits in with the world of procurement software in the earlier years of development. This Part 2 focuses on the second wave of developments in PCM: feature-based automated 3-D CAD costing tools, advanced cost-accounting and control systems; the role of little and big data; and the future of product cost management.

To recap, it’s important to consider that purchasing has added a lot of new tools to what was mostly a relationship-focused discipline. These developments include:

  • Data-rich environments of spreadsheets, MRP and ERP systems
  • Supply chain management and supplier relationship management systems
  • Online auctions
  • Spend analytics tools/product cost management (PCM) software

And it’s important to recall our roadmap to this journey through time and technology, which is shown in Figure 1. Notice that the 3-D CAD development is the latest one. Let’s explore how this has developed and what it has to offer businesses today….

Curious?  Yes, you are.  To read the epic conclusion of the PCM softwares on the market today, what they can (and can’t do) and how they can generate impact for your company ,read more here!

 

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Dec 182019
 

Hiller Associates is pleased to announce a new article in SpendMatters.com! Spend Matters plucky founder, Jason Busch was having a conversation with our founder, Eric Arno Hiller, about the growth of the market of Product Cost Management software and the state of the art today.  Well, that is chicken soup to Eric’s soul.  It’s a TWO-part series, so read this one and look for the next very soon!

Here’s a teaser: (but, if you’re just impatient, click here)


A lot has happened in the world of procurement software in the last 20 years. Purchasing has added a lot of new tools to what was mostly a relationship-focused discipline. These developments include:

  • Data-rich environments of spreadsheets, MRP and ERP systems
  • Supply chain management and supplier relationship management systems
  • Online auctions
  • Spend analytics tools/product cost management (PCM) software

Although the relationship side of the business is just as important as ever (some might say more important), purchasing analytics are here to stay, and they continue to become more prevalent in the discipline. The same is true for product cost management tools and their offshoots of service cost management tools. In this series, I am going to discuss the evolution of these tools and the state of the art.

Our roadmap to this journey through time and technology is shown in Figure 1….

Curious?  Yes, you are.  To learn about what softwares are on the market today, what they can (and can’t do) and how they can generate impact for your company,read more here!

 

 

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Nov 042019
 

Image result for supply chain brain logo

Hiller Associates is pleased to announce its first article in SupplyChainBrain!  As usual, it’s on a most fascinating of topics… well at least to us:   Tariffs and their effects on your products.

Here’s a teaser: (but, if you’re just impatient, click here)


Total cost of ownership (TCO) was popularized by Gartner in the 1980s. The basic idea is that the value derived from a product involves more resources than what you pay the supplier.

TCO is essentially a consumer-facing concept, but another term, total cost of acquisition (TCA), has more of a supply-chain and procurement application. In the past, it was less important in the U.S., as the nation gravitated toward free-trade pacts such as the North American Free Trade Agreement (NAFTA). That has changed under the current administration. In addition, because of automation and the development of manufacturing sites in other countries, TCA is regaining importance in the U.S.

Today, a manufacturer might have multiple choices of suppliers within overwhelmingly complex supply chains. How does the modern purchasing professional sort out which option is best?

Let’s break it down to three steps:

  • What? Understand the supply-chain options strategically.
  • How much? Populate the numbers for each assumption tactically.
  • What does it mean? Quantify the total and understand where the costs are.

Etc…

Curious?  Yes, you are.  To learn how tariffs can impact your Total Cost of Acquisition / Ownership, read more here!

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Oct 172019
 

For the impatient:  To see the analysis of Illinois Football, CLICK HERE!

Download the analysis here:

==============================================================

Sometimes you just have to step away from helping clients with design-to-value teardowns and ideation and Product Cost Management to consider the less fortunate.  In this case, the less fortunate include our Managing Partner, Eric Arno Hiller, and his fellow alumni at the University of Illinois, Urbana-Champaign.   

Sure, it’s one of the greatest engineering schools in the universe (…or is it the “multiverse?”), has produced a large number of Nobel Prize Winners, and has respected alumni and programs in a plethora of disciplines.   But, let’s talk about what really matters to most people in the world of large American universities:  College Football.  Eric has done an analysis of Illinois Football and coaching.

According to Eric:

I have loosely followed Illinois football since I was a freshman in 1991, through my time recruiting many interns and full time people to Ford Motor Company as a young engineer, through being president of the Boston Illini Alumni Club, through moving to Chicago — the heart of Illini alums on earth.  

Until circa 2007, I veritably bled orange and blue.  This was due to my experiences with student leadership in the College of Engineering and personal experiences, far more than the sports.  But, after being friends with enough Wolverines and Buckeyes and Badgers, I really did get perplexed and irritated about what is really going on with Illini Football.   So, while visiting my college roommate, I was inspired to do a little analysis.

Eric wanted to answer the following questions:

  • Is Illini football performance really as bad as I perceive it to be?
  • Is this a new phenomena, since I became an Illini, or have my older Illini brethren struggled here as well?
  • Was Illinois ever good?
  • What coaches were the greatest in history?

Along the way, the data led Eric to some other interesting insights that he shares in with the graphic flair of a recovering engineer and recovering McKinsey consultant.   

To see the analysis of Illinois Football, CLICK HERE!

Download the analysis here:

Image result for university of Illinois football

Eric also started to think about what to do about the problems with which Illinois struggles, and tries to scratch the surface of a solution.   Find out what he says in the analysis!

(Spoiler alert!:   Don’t expect miracles — generating hundreds of millions in impact for clients with design-to-value, Product Cost Management, and great product management is in Eric’s wheelhouse.  Touchdowns on the gridiron, are a bit outside of it.)

 

 

 

 

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Oct 162019
 

OK, Hiller Associates is back in the saddle again!     And, we have a our latest article posted in: 

 

 

IndustryWeek.

Dullsville Just Got Interesting

by Eric Arno Hiller
 
The most boring parts of cost analytics are the difference between success and failure.

 “What does this mean?”

That’s an excellent question and one that a purchasing professional should be asking any time they receive a quote from a supplier or a cost analysis from their Product Cost Management team.  Sadly, however, many times, purchasing professionals don’t even vocalize this question to themselves, much less to their analytics teams, even after the analysis is presented. Instead, they just feel uneasy and uncertain about the validity of the cost analysis.  This is a dangerous position, because once the supplier smells that lack of confidence in a negotiation, it’s all over. … read more!

That’s just a teaser, as is this simplified diagram.

Curious?  Yes, you are.  To learn why everyone is confused about what your cost estimate means, after your team spent so much time calculating it, read more here!

 

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Nov 212017
 

Hello all!  

As some of you may know, I joined McKinsey & Company a little over two years ago as an expert in their Product Development Design-to-Value practice.  (Don’t tell anyone, but I do a lot of work for clients in the purchasing space, too!).

It’s been a whirlwind of a couple years, but I finally got some time to publish some new thought leadership.    I just did this on McKinsey Ops Extranet, sadly not here.  But, the good news is, you can join for FREE, so don’t be worried when you see you need to register.

Here’s the first.  Enjoy!  Oh, and may sure to 5-star my post if you read it and like it.  Thanks.

 

What should it cost? 

(Welcome to the standard costing party! What’s this all about?)

 

 

 

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Jun 052014
 

IW_LogoNEW ARTICLE in Industryweek.com by Hiller Associates

Synapsis:  No matter how badly you think you are pinned down in a pricing negotiation, there are always tools for leverage that can help you improve your position. Relative should costing is one of these powerful tools.

To read the article at Industryweek.com, click here.

Or, you can read the full article below

==================

Relative Cost Power – How to not know the cost of your products and win negotiations, anyway

With product cost accounting for 70 to 90% of every revenue dollar on the income statement, it’s not hard to understand why cost is such a big deal to many companies. In the last decade, there has been a renewed focus on the world of Product Cost Management, including techniques like Design for Manufacturing (DFM), Should-Costing, Spend Analytics, etc. Many of these techniques are used (or are intended to be used) *before* the sourcing phase of the Product Life Cycle. While procurement professionals should be involved up front in product design, a lot of the responsibility for success with these techniques will rest on the design engineering staff.

Regardless of whether your company is best-in-class in Design-To-Cost, or whether you have the most cost-oblivious design staff in the world, your designs must be eventually made or bought. With the dominance of outsourcing, it’s more difficult than ever to know what the should-cost of a product is? Purchasing agents are told that they should know the should-cost of products before they walk into a negotiation with a supplier. However, that is not easy, and the fact is:

Your supplier will typically know more about their costs than you do.

So, how do you precede in a negotiation where your supplier has more and better information? Are you completely at their mercy? And, what if your supplier holds oligopoly, or even monopoly, supplier power? Are you just a price taker?

ANSWER: No, you don’t have to be a price taker, at least in the case of buying multiple variants of a similar spend item.  Recently, I wrote a blog post about how the human brain does not like non-linearity, discontinuity, or non-monotonic functions. This is a fancy way of saying that people are very good at detecting pricing inconsistencies within multiple similar products.

This inconsistency is the key to being able to better control a negotiation, in which you really don’t know what the absolute cost of a product should be, or where you know the should-cost, but have little buyer power. Let’s explain this with an example:

Case Study in Relative Should-cost: Pick-up Truck Driveshafts

Hiller_Associates_Relative_Should_DriveshaftsIn the late nineties, I had the privilege of being the product development owner for the drivelines (axles and drive shafts) used in the full-size pick-up that was best-selling vehicle in the world for over 30 years. This truck made over 100% of the profit for my employer (making up for losses on other vehicle lines). I was very young and inexperienced at the time, so it was a great experience, but a big challenge.

Within the first few weeks in the assignment, I was told that it was time to negotiate the contract for the driveline commodity (over $450 million annually) for the upcoming 2004 vehicle. I was told that this was a very complex process, but that the purchasing group would lead it. However, my first meeting with our purchasing team lasted about 10 minutes… long enough for the purchasing team to say: “Oh, your supplier is *that* supplier? We don’t get involved with them. Have a nice day.” And, they walked out of the room.

After the shell shock of the experience wore off, my manager explained that our supplier was the former components division of our employer (the OEM) and that our CEO had desperately wanted to spin-off the component divisions from the OEM. To do this, our CEO had negotiated a deal with the powerful automotive union, agreeing that the union members would technically work for us (the OEM), but be leased to the newly spun-off supplier. If the OEM did not give enough business to the components supplier to keep the union members employed, the OEM was responsible for paying them a large portion of their wages, while they waited to be deployed somewhere else.

Effectively, this removed almost all negotiation power from us, the OEM. Therefore, our purchasing team had made a decision at the executive level to not participate in negotiations with this particular supplier. Instead, these negotiations were dumped into the laps of the product development team, with some support from finance.

Suppliers with Complete Supplier Power

The product development team had its own problems already. The marketing team were demanding much better performance and quality out of our parts. But, the finance team demanded that those parts be cheaper than the previous generation of parts! And now, we had an AWOL purchasing team. In terms of the old Porter’s Five Forces framework, our supplier had tremendous supplier power! What to do?

I certainly was not an expert in drivelines yet, but I had just completed a master’s thesis focused on product cost. So, I first reached out to the cost estimation team within the OEM. They helped us understand what the absolute cost might be for a driveshaft. We were also able to negotiate with the purchasing to do an “unofficial” price study with other driveline suppliers.

Our first negotiation with our supplier (the OEM’s former component divisions) was pleasant, but utterly futile. I excitedly explained what we thought the absolute part cost of these driveshaft parts should be, and hinted that we had quotes from other suppliers to prove it. Our supplier, being quite shrewd, politely explained why their product was, obviously, so much more valuable, combined with a tangible undercurrent of, “Well that’s nice that you have should-costs and quotes from other suppliers, but we really don’t care, because you have to use as a supplier regardless.”

Relative Should-Cost to the Rescue

Now what were we going to do? These lines of argumentation (absolute should-cost and competitive quoting) were not prevailing on the supplier. So I tried something different: Relative Should-Costing.

Hiller_Associates_Relative_Should_CostA driveshaft is complex in many ways, but in reality, it is a modular part design. It’s constructed mostly of the end yokes coupled with an extruded or seam-welded tube between those yolks. If we had a longer truck we simply extended a tube. (For technical safety reasons, we had three variants: a 1-piece steel driveshaft, 1-piece aluminum, and a 2-piece steel.)   In total, we had over 70 part numbers of these three designs, and we knew the price quote for each variant.

Using a spreadsheet, I simply estimated a reasonable cost for one driveshaft tube for each of the 3 variants. With this estimate, it was easy to calculate a per-inch cost of that tube. By subtracting, I knew what all the other parts in the driveshaft (e.g. end yokes) approximately cost. That was all I needed. I didn’t need to know what the absolute cost of each driveshaft should be.

I just needed to know what each similar part should cost RELATIVE to another part.

In the second negotiation, we politely questioned the supplier on their confidence in their pricing ability. They professed with great certainty that they knew how to price and stood by those prices. Then we coyly pulled out the part numbers for the three drive shafts for which I had estimated the absolute, and asked if they stood by those prices. They eagerly declared they stood by those prices. Gotcha!

At that point, we started asking how Part B that was 5 inches longer of extruded tube than Part A could cost $10.00 more than Part A, when the tube extension was only worth $0.30. The supplier was not sure and asked for time to investigate. We had several more meetings on the topic, but in the end, the supplier could not give any logical reason why their pricing for similar drive shafts varied in bizarrely non-linear ways.

The supplier reduced the cost of the entire driveshaft commodity by about 8%, resulting in about $35 million a year, straight to the bottom line of my employer, the OEM.

Should the discount have been bigger? Yes. Did my calculations show that the supplier should have given us more money? Yes. But, did we get a significant concession from a supplier who held every card in this negotiation? Yes we did!

In reality, the supplier still could have refused to reduce their costs. However, the point of these Relative Should-Cost negotiation techniques is to bring logic and facts to bear to increase leverage in a situation where you seemingly have no leverage.

The win occurred when the supplier just couldn’t answer why their own pricing was internally inconsistent with itself.

This is a good lesson for suppliers to learn, as well. When quoting a basket of similar parts, it’s wise to make sure that you understand your own pricing and reflect the underlying costs in a logical and linear way to your customer. This greatly reduces the risk of your customer casting doubts and driving your pricing down, perhaps unfairly.

Diagnostic vs. Leverage Tools and Absolute vs. Relative Should-Cost

The case study above is an example of the difference between using a Relative Should-Costing technique, versus an Absolute Dollar Should-Costing technique. If this sounds interesting to your company, you may want to read more in my previous article in Industryweek.com, Your Should-cost Number is Wrong, But It Doesn’t Matter. In this article, we talk further about using should-costing, not only as a diagnostic gage to tell you what the cost is, but as a tool for leverage to move the cost down.

Remember, no matter how badly you think you are pinned down in a pricing negotiation, there are always tools for leverage that can help you improve your position. Relative-Should costing is one of these powerful tools that should be in your tool box.

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