The Random House Unabridged Dictionary defines risk as, “The exposure to the chance of injury or loss; a hazard or dangerous chance.” In public procurement, the focus is often not on risk but keenly focused on price; the general public expects, and conventional wisdom dictates, that we find the lowest price. But we should remember the old joke in which the astronaut said: “Just think, we are sitting on a rocket with a million moving parts all provided by the lowest bidder.” What other factors beyond price come into play? More to the point: How does risk play into public procurement, and how do we begin formally incorporating risk management into the process? In the age of COVID-19, how does risk play into the strategies, objectives, and actions in the procurement process?
Incorporating risk into procurement is not new; however, recent research points to opportunities that enable an organization to focus on risks that are important to success through assessment, identification, procurement and management.
According to an Aberdeen Group study: Smart Strategies for Tough Times, 71 percent of CPOs view supply risk as having increased in the past 18 months, yet only 38 percent of best-in-class organizations are developing supply risk mitigation strategies. As COVID turned supply chains upside down, procurement organizations scrambled to meet the demand for commodity groups that were normally considered inexpensive consumables, if they were considered at all.
There is an area of opportunity for risk-based procurement. The following approach was developed and presented by Dave Porter of the PMMS Consulting Group in Procurement Strategy Guidance.
Assessing your procurement
A Pareto analysis of suppliers generally supports the well-known “80-20 rule,” i.e., we buy 80 percent of our goods from 20 percent of our suppliers. Understanding which suppliers provide the bulk of products and services provides us a better perception of the playing field where we operate. The next component is to understand the risks associated with the procurement, including factors such as:
- Market Difficulty: What is the extent of real competition in the market?
- Complexity in Switching: How difficult is it to replace the supplier?
- Business Impact: What is the impact if something goes wrong (safety, environmental, legal, etc.)?
Using the risk factors, you can rate procurements in relative terms to each other based on risk. Some simply use a scale of 1 to 5 for each segment, with total risk being the sum of the factors.
The Procurement Quadrants
Using the dollar volume of spend and the relative risk, procurement can be broken into four quadrants, as depicted in the first diagram.
The quadrants can be described as:
- Tactical Acquisition: Low value, low business exposure, e.g., office supplies.
- Tactical Savings (or cost-reduction): High cost without the quality, safety issues and large number of suppliers, e.g., desktop computers, copier services, cell phone service. While government is not a “bottom line”-oriented entity, it can focus on areas where prices can be reduced.
- Strategic Security: Low value but have quality, safety, reliability, environmental issues coupled with availability of suppliers, e.g., mission-critical water pumps, shuttle-bus service for schools. In the age of COVID, PPE supplies moved into this category from the Tactical Acquisition quadrant.
- Strategic Critical: High cost, high risk (quality, safety, supplier pool), e.g., bridge or office building construction or an ERP implementation. COVID related supplies such as ventilators, specialty equipment, and medications moved into the quadrant, many from the Tactical Savings quadrant.
While the diagram depicts an equal horizontal distribution 5 to 10 percent of spend, or 70 percent of vendors, should be in the left two quadrants.
Using the NIGP Code for Analysis
When determining how to correlate spend with risk, the NIGP Code plays a natural role. By using the NIGP Code to track spend data, we have a mechanism to group procurement spend in order to build discrete market baskets for analysis. Your organization may roll up spend by 5-digit code or at the 3-digit level. Either way, it provides an excellent grouping mechanism. In this scenario, the agency should be re-evaluating the risk profile for PPE, hospital equipment, medical supplies and pharmaceuticals. Once bundled, the risk factors can be applied to determine the relative risk associated with the market basket, as depicted in the second diagram:
With each quadrant, the goals and objectives are different, with the strategies for execution and metric for success also being different.
- Strategic Security: Ensure supply through long-term contracts, potential inventory holdings, identification of alternative products, and use of price indexes.
- Strategic Critical: Manage supplier through detailed market and supplier knowledge, use of purchase price and cost analysis (are you paying a fair price?), and contingency planning for supplier or product/service replacement.
- Tactical Acquisition: Minimize attention by using P-cards, blanket agreements, delegated authority and supplier website ordering.
- Tactical Savings (or cost reduction): Drive lower costs through short-term contracts, framework agreements (where terms and conditions are negotiated with contracts being issued for work/products as needed), in-depth market knowledge and flexibility in the products and services requested.
As the pandemic spread, who would thought that hand sanitizer, gloves, N95 masks, gowns would suddenly become scarce? As agencies raced to secure products from existing suppliers, they often found their contract vehicles did not provide adequate assurances for supply continuity. Other complex products with long lead times for productions, e.g., ventilators and anti-viral medications, became unavailable due to supply chain issues compounded by a lack of overall coordinated demand validation between competing nations, states, agencies, cities, and counties.
Calculating the burn rate of PPE and supplies is a critical component in managing the supply for Strategic Critical and Strategic Security market baskets. In April 2020, The Centers for Disease Control (CDC) published an article “Personal Protective Equipment (PPE) Burn Rate Calculator,” to assist in calculating the amount of masks, gloves, ventilators, and other supplies based on COVID cases. Using local infection rate data, current on hand supplies, and the burn rate model, estimated demand can be calculated for best, average, and worst-case projections. Based on the projections, procurement can work to secure needed supplies through existing and new agreements and coordinating supplies and equipment with other agencies.
While a vaccine for COVID will begin rollout in the coming weeks, the pandemic will extend well into 2021. Procurement organizations will need to continue to monitor infection rates and execute on supply initiatives to prevent shortages as cases rise and fall over the next year. As the world recovers, post-emergency reviews will be required to identify supply chain and procurement shortcomings and opportunities to better plan for future pandemics.