When 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.”
Mitchell says that “HP hasn’t yet learned how to take internal capabilities and turn them into external successes.” But more important, he says, is the issue of whether the corporate world is ready to open up its wallet for technology that pays off only when something goes wrong. “Most companies are biased toward quick-hit reward-seeking,” he says, “not long-term risk avoidance.” But he agrees that supply-chain risks demand more attention from companies. Whether HP can get them to put their money where their risks are remains to be seen.
Doug Bartholomew is a writer in Berkeley, California, and former technology editor at IndustryWeek.
A Facility for Agility
If you’ve ever felt that the pace of change was leaving your company in the dust, it might be time to try what Steelcase Inc. did, and get an agility checkup.
The office-furniture maker was looking for ways to adjust both its business strategy and the way IT supported that strategy so that it could adapt more quickly to shifts in pricing, changing customer preferences, and competitive pressures. “Not just at the IT level but also at the business level, we wanted to identify where we had gaps,” explains John Dean, CIO at the Grand Rapids, Michigan-based company.
Enter Hewlett-Packard, which has developed an Agility Assessment Service that includes something it calls the Agility Index. Using a set of vertical-industry performance indexes developed in a joint effort with INSEAD, the international business school based in Fontainebleau, France, HP says it can take the agility pulse of almost any company in each of four industries: telecommunications, manufacturing, financial services, and IT services. HP found three important measures related to a company’s agility: time (how fast an organization can make changes), range (how well change can be embraced across an organization), and ease (how much effort is needed to make changes). “We measure how companies compare as they react to change,” says HP’s Mike Hill. “We look at the significant business processes that drive the business.”
Oddly, the joint research showed that companies’ ability to respond to change has declined, rather than improved, in recent years. “The startling reality is that while market change continues, companies’ ability to respond is often impeded by the rigidity of their processes or the state of their IT infrastructures,” says Kishore Sengupta, associate professor of information systems and research program manager at INSEAD. With HP’s own agility now put to the test, it has the opportunity to serve as its own best case study.—D.B.