VideoWhen Carly Fiorina unexpectedly resigned as CEO of Hewlett-Packard Co. last month, the question was raised yet again as to whether HP is caught in a no-man's land between the vast product and services offerings of IBM and the ruthless cost-competitiveness of Dell. While it's far too early to tell whether new leadership at HP will translate into a new strategy, two nascent efforts at the company hint at some future product and services offerings. One is a homegrown procurement system that HP plans to turn into a commercial product later this year. The other, also based on HP's own experience, is a consulting service that attempts to put some hard numbers behind the hazy concept of "agility" (see "A Facility for Agility" at the end of this article).
The procurement product can trace its roots to 2000, when HP confronted a shortfall in availability for the flash memory devices used in its highly profitable laser printers. The booming cell-phone market was hungry for those same components, and with the security of its profitable printer line hanging in the balance, HP opted for a long-term binding contract to ensure the supply of flash memory devices at a capped (that is, higher) price.
The company could have simply signed the contract and soldiered on, but its supply-chain managers, cognizant that HP spends a whopping $60 billion a year on parts, wanted a better solution. So the company initiated a Procurement Risk Management (PRM) program that attempted to give HP a better window into supply versus demand and extrapolate the economic implications. The goals were to evaluate how much HP should pay for flash memory in the next few years, how much flash memory to purchase, how far out the contract should run, and how to structure it to guarantee compliance.
Since then, HP has expanded its PRM process (and the software that supports it) to evaluate its needs and optimum prices for not only printer supplies but also energy and packaging materials. HP figures it has saved more than $70 million to date, and it's just getting started: only $3 billion worth of HP's spend—or about 5 percent of the total—is managed using PRM. "We are the number-one buyer in all the different commodities we purchase," says Patrick Scholler, director of HP's Procurement Competitive Edge initiative. Some 500 procurement staffers have been trained to use the PRM system and procedures. "We are actively promoting risk management as a strategy within the company."
While many E-procurement (aka spend management; see our Buyer's Guide, page 44) efforts encompass contract negotiations and compliance, HP's approach is both unusual and ambitious because it brings risk-management techniques to bear. "HP's PRM is a set of tools and procedures they use internally to decide how to place their bets on certain components and materials," says Pierre Mitchell, a director at consulting firm The Hackett Group. "Few manufacturers do this in a structured way."
How It Works
And structured it is. Using a sophisticated hedging system not unlike those used by options traders and other financial investors, HP in effect takes out options to buy various parts, components, and materials at set prices over a certain time frame. The company is willing to pay a small premium to guarantee availability within a certain price range. "The idea is to be able to hedge against price variations and shortages," explains Mitchell. "When prices suddenly go up on fuel and steel, the companies that are ahead of the curve are those that have in place some hedging strategies to cope with this scenario. Let's face it: CFOs don't want surprises when it comes to pricing."
In contrast, most manufacturers spend lots of time forecasting demand for finished goods, while devoting little or no effort to future price shifts for or availability of direct materials used in their products. Says Mitchell, "Manufacturers often assume the prices for goods and parts will remain the same or, if they fall, they will be able to rebid their contracts. But they have no way to hedge when prices go up unexpectedly or when external factors affect supply. Look at what China's demand for steel has done to global prices—they've tripled."
For memory chips, HP designed a custom options contract that pays suppliers a premium for the option to buy a fixed quantity of memory devices at a capped price. The premium was set at 5 percent of the strike price, and the contract was bid to suppliers for delivery in three months. If prices increase above forecasted levels, the option is exercised at the fixed strike price for the agreed-upon quantity. Conversely, if prices fall significantly below the strike price, the procurement teams can let the option lapse and buy in the open market for less. Although there is the cost of the option price, HP figures this expense is often less than the exposure cost of carrying excess inventory. "There is some cost, but very clearly the benefits far outweigh the cost incurred," says Venu Nagali, leader of HP's PRM group.
Having developed both a process and accompanying software, HP says it will begin to market PRM to other companies within the next few months. "We've shown it to some of our customers and have gotten good feedback," Scholler says, "but we need to put in place the structure to sell such a service."
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