Using a spend analysis to help identify prospective Air Force purchasing and supply management initiatives : summary of selected findings

Nancy Y. Moore ... [et Al.] Prepared For The United States Air Force. Rand, Project Air Force. Includes Bibliographical References (p. 85-89). Using a Spend Analysis to Help Identify Prospective Air Force Purchasing and Supply Management InitiativesSummary of Selected FindingsBy NANCY Y. MOORE CYNTHIA R. COOK CLIFFORD A. GRAMMICH CHARLES LINDENBLATTRand CorporationCopyright © 2004 RAND CorporationAll right reserved.ISBN: 978-0-8330-3582-0Chapter One INTRODUCTION The U.S. Air Force (USAF) faces an increasingly broad array of tasks calling for changing force structures and new weapon systems. Competing goals can make it difficult to decide which initiatives to fund most generously. In sum, the Air Force faces even greater pressure to make the most of its existing resources. In FY02, the total Air Force budget was $100.3 billion. More than two-thirds of that amount, or $69 billion, was spent on weapons, goods, and services. The Air Force has the most control over this portion of its spend, and hence this is where it can most likely realize savings from improved purchasing and supply management (PSM) practices. Half of the total Air Force budget goes to direct purchases from organizations outside the government. This direct Air Force spend includes an enormous amount and variety of goods and services in a large number of industries. These include aircraft and other weapons systems, ammunition, spare parts, repair and base operating services, automatic data processing equipment, software, and other goods and services. Nearly all these expenditures are for contracts worth at least $25,000. For such contracts, there is a substantial amount of data available for analysis. In this report, we examine these data and what they indicate for Air Force purchasing practices. In determining how to apply best purchasing and supply management practices, the Air Force may wish to learn from commercial firms. As with the Air Force, commercial firms have had new reasons, such as increasing global competition, to make the most of their existing resources. The resulting increased reliance on outsourcing has led them to seek improvement in purchasing and supply management practices. A growing body of research documents how innovative commercial firms are better managing their suppliers, supply base, and supply chains, and applying a number of best purchasing and supply management practices (Moore et al., 2002). These firms report that they have generated significant savings and measurable performance improvements from their efforts. A first step toward improving purchasing and supply management is to conduct a spend analysis, or an analysis of expenditures along a number of dimensions, such as type of commodity and supplier, number of contracts and amount of expenditures, and other variables showing how a firm currently spends its money on goods and services. Private firms place great value on such analyses; a recent survey of 157 supply chain executives revealed that 80 percent view spending analysis as "very important" or "critical" to their enterprise's success (Aberdeen, 2002, p. 6). A spend analysis can help enterprises improve their purchasing practices in the areas where they are likely to produce the greatest benefit (Sawchuk, 2002). A spend analysis can help the Air Force answer several questions that might help it target its purchasing and supply management initiatives. These include Where can the Air Force apply new purchasing and supply management practices to enhance and improve its performance (e.g., responsiveness, quality, reliability, flexibility, etc.)? Does the Air Force have the necessary data (e.g., centralized data on supply and management contracts) to support the use of these practices, and can the data it does have be used to identify opportunities for improvement? What can the Air Force do to better apply purchasing and supply management practices in procuring the goods and services that it needs? In this report, we describe and provide an overview to our approach for a high-level spend analysis. We describe Air Force data available for such an analysis, review indicators of prospective Air Force opportunities for applying improved PSM practices, examine the insights available from the data that the Air Force already collects that are relevant to a spend analysis, and identify the lessons of greatest importance from current data. We selected the data, collected through the Air Force Contracting Data System, J001, on transactions of at least $25,000, known as the "DD350" data (after the form used to report the contracts). Chapter Two OVERVIEW OF SPEND ANALYSIS We begin with a description of a spend analysis and what the Air Force can learn from one. Second, we examine prospective opportunities that the Air Force has for applying better PSM practices, or areas it might want to examine more carefully to improve its supply strategies. Third, we offer some insights available from data that the Air Force already collects. Finally, we discuss steps the Air Force might take to better gather and analyze spend analysis data that can lead to improved PSM practices. First, a spend analysis is an evaluation of enterprise-wide Purchases, or what an enterprise is buying, including purchases by product or service, dollar value, number of contracts, supplier, and purchasing organization Supplier base, including suppliers by industry, firm, geography, risk, dependency or the percentage of business that a firm gets from a single customer, and socioeconomic variables. Although such an analysis can be time-consuming and labor-intensive, private enterprises have found that without a spend analysis it is difficult to identify prospective targets for applying better PSM practices, develop supply strategies for specific commodities, select the best suppliers, manage suppliers in a way to maximize rewards and minimize risks, and convince all senior leadership of the need to shift to best PSM practices and of the need for resources for the shift. Spend analysis data can reveal targets of opportunity where altering purchasing practices could result in significant performance improvements or savings. Enterprises may have different divisions unknowingly buying from the same supplier. For example, within the Department of Defense (DoD), there are multiple contracts with a single firm for jet engine components, which may not be optimal. A spend analysis can identify such patterns and resulting opportunities to leverage buying power by consolidating contracts with and across suppliers. A spend analysis combines analytical and benchmarking techniques (as developed by such consultants as Dun and Bradstreet and Answerthink) to help identify prospective opportunities and current risks in purchasing and supply management. Many enterprises classify or segment their purchases by dollar value (i.e., spend) or business volume (number of transactions or suppliers) of spend. More recently, innovative companies have begun to classify their spend by vulnerability (e.g., risk or exposure to market failure in procuring a good or service, strategic importance of purchased goods or service), and value (e.g., effect of a purchased good or service on overall costs or profits). Supply segmentation by vulnerability and value (also called positioning) is based on Modern Portfolio Theory for quantifying the relationships between risks and returns (Olsen and Ellram, 1997). Purchased goods and services with similar levels of vulnerability and value are grouped together for purposes of allocating purchasing resource and developing of supply strategies. For example, goods and services with the highest levels of vulnerability and value are often assigned the most senior/qualified personnel and most resources. These personnel then develop proactive supply strategies and adjust their sourcing approach and relationships to market and supplier conditions for the product or service. They also continually manage suppliers and the supply base. In sum, a spend analysis integrates internal spend data and external supplier and market data and applies analytical and benchmarking techniques to help identify risks and opportunities for performance improvements and savings by applying best practices in purchasing and supply management. It reviews corporate family relationships to identify interrelated or duplicate suppliers. It can also be used to measure compliance with preferred vendor programs. This research is a direct outgrowth of RAND research on the implementation of innovative PSM practices at commercial firms (Moore et al., 2002). The authors found that, among innovative private firms, spend analyses are emerging as a first step in developing supply strategies-a best PSM practice. As part of its effort to improve purchasing practices, the Air Force asked RAND to conduct a first-order spend analysis of Air Force data. To examine how the Air Force might conduct a spend analysis, we first reviewed existing literature, interviewed managers at innovative firms, and gathered information at conferences for purchasing professionals. We then collected Air Force purchasing data to identify major components of total Air Force expenditures. In addition to the Air Force data, we also gathered DoD-wide data. Other DoD branches buy components similar to those the Air Force purchases (e.g., Navy purchases of aircraft engines). It may be that both the DoD and its individual branches can benefit from consolidating such purchases. There were some difficulties collecting this widely dispersed data, not all of which provided with equal fidelity information required for a spend analysis. Once we put together as many major data components as possible (given project resources) on total Air Force expenditures, we analyzed the data for prospective opportunities to apply best PSM practices. For further in-depth analyses, we selected the data, collected through the Air Force Contracting Data System, J001, on transactions of at least $25,000, known as the "DD350" data (after the form used to report the contracts). These data proved to be a rich source of information on Air Force purchases, although they had some problems. (See Appendix A for a discussion of quality issues in DD350 data.) We also identified areas where other information or analytic capabilities are needed to help the Air Force develop supply strategies and apply best PSM practices. For our analyses, we tried to find data for intragovernment purchases made both within and outside the DoD. We found that these data are generally not collected in any central place within the buying or supplying organizations. They are available only within myriad Defense Financial Accounting Systems data, analysis of which was beyond the scope and resources of this project. Any sourcing decision has the potential to yield rewards or introduce risks to operations (Moore, 2002; Sawchuk, 2002). The rewards include opportunities for performance improvements and savings (Aberdeen, 2002). Risks arise in situations where overall performance could suffer as a result of issues related to supply chain or supplier performance, like delays in procurement of critical parts, variable quality of procured commodities, or increasing costs. Opportunities for savings result from the potential for increased leverage, economies of scale or scope, and reduced transaction costs (Moore et al., 2002). A spend analysis that identifies suppliers with multiple contracts, similar products or services being provided by multiple suppliers, or different agencies purchasing identical goods or services offers evidence of prospective opportunities for savings through consolidation of purchases. A spend analysis finding supplier cost growth exceeding that of the Producer Price Index (PPI) indicates that a supplier may not be doing enough to control costs or to identify opportunities for savings (see Ellram, 2002, for an example of how John Deere measures cost savings relative to the PPI). Opportunities for performance improvement are indicated by supplier performance data demonstrating varied or poor quality or delivery, long wait times, little information-sharing or supplier innovation, and few multiyear contracts. Innovative suppliers may apply different strategies to different groups of customers, just as, for example, airlines provide better service to their most frequent flyers-and most profitable customers (Steel and Court, 1996). Prospective sourcing risks can be indicated by cases with Only one supplier or limited competition or substitution capabilities, which could lead to opportunistic behavior by suppliers (Williamson, 1985). Past reports of the Inspector General have documented opportunistic behavior by defense contractors, including overcharging or incorrectly billing for their work. Suppliers with financial problems, which may cause a supplier to go out of business or shirk on performance (due diligence regarding supplier finances and capabilities are among standard practices to prevent supplier problems or default). Low or variable demand making it difficult to find and retain good suppliers. (Suppliers prefer more stable workloads because highly variable workloads increase costs (Hahn, Kim, and Kim, 1986). Suppliers also need a stable amount of business to maintain specialized equipment, retain personnel, and otherwise continue operations.) No contract in place. Buyers may not stock low-demand goods, and some buyers such as the DoD may not have a contract in place to procure low-demand material. This can add time to the supply process when personnel have to identify one or more suppliers, go through the bidding process, select, negotiate, and finally establish a contract-all the while increasing the likelihood of permanently losing suppliers of unique DoD goods and services. No supplier performance incentives or commitment to improve, or a prescriptive, rather than an outcome-oriented, statement of work, which limits improvements. (The Air Force is in the process of developing more performance-based contracts.) Inadequate or poor past performance information, preventing identification of the most innovative firms. Inappropriate scopes of work, with contracts having too little or too much work, creating diseconomies of scope and leading to decreased performance or increased costs. Some of these factors may be relatively simple to identify in existing data. Others must be researched more carefully using additional internal and external data sources. Indicators showing prospective opportunities for savings or performance improvements or possible risks from applying best PSM practices can help in targeting such activities for PSM initiatives and tailoring supply strategies to specific circumstances. We examine in more detail opportunities the Air Force might find from indicators of prospective PSM rewards, including prospective savings indicated by products or services with many suppliers, suppliers with multiple contracts, many independent buying organizations purchasing the same good or service, and how potential benefits may be limited by sole source or reduced competition. Collecting data for a spend analysis is not simple, particularly when data sources are not centralized, do not cover all purchases, and do not provide the fidelity needed for a good spend analysis. All this is true of Air Force purchasing data. (Continues...) Excerpted from Using a Spend Analysis to Help Identify Prospective Air Force Purchasing and Supply Management Initiativesby NANCY Y. MOORE CYNTHIA R. COOK CLIFFORD A. GRAMMICH CHARLES LINDENBLATT Copyright © 2004 by RAND Corporation. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site. This briefing summarizes research on how the Air Force might use an analysis of its spending to develop better supply strategies, improve its relationships with suppliers, and better manage its supply base. Best practices offer many ways by which the Air Force can improve performance and save money. Such techniques include consolidating multiple contracts with existing providers, selecting the best providers and offering them longer contracts with broader scopes of goods and services, and working with selected strategic partners to improve quality, responsiveness, reliability, and cost. There are many challenges to conducting an Air Force-wide spend analysis, primarily the lack of detailed, centralized data on all expenditures as well as questions about data quality for those data that are available. Nevertheless, the data that do exist point to many prospective sources of savings and performance improvements. The authors analyze the most complete centralized source available on Air Force expenditures, known as DD350 data. Transactions in the DD350 data constitute 96 percent of all Air Force contract dollars spent directly. Among the actions that the Air Force might wish to take are: consolidation of a large number of contracts with similar or the same supplier; grouping contractor ID codes having multiple contracts with the Air Force and many purchase office codes associated with the same contractor, so that the Air Force does not have to pay for the contractor's repetitive bidding and contract administration costs; examining contracts for goods or services available from only one supplier, which gives the Air Force only limited opportunities to gain leverage over such suppliers. Conducting a detailed Air Force spend analysis would require information on the needs, preferences, and priorities of commodity users not available in the DD350 data. Because the Air Force needs to balance prospective savings, performance improvements, risks, socioeconomic and other goals, and other regulations not always present in the private sector, not all best commercial practices may be appropriate for it