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In the News | Procurement and the Stock Market

  

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With rising fear of another Lehman's Brothers episode, how can procurement influence the stock market?

August 2011 saw the worst stock market crash since 2008, resulting in wide spread panic from global investors. Fear of another Lehman's Brothers episode was rumoured which led four EU markets imposing a strict ban on the practice of ‘short selling’ for a period of 15 days.

US banks responded to the same negative market movement by dropping interest rates to 0% (a record low) in hopes of encouraging investors to return to the market.

Why is this significant / Why now?
With the downward trajectory of global markets, PLCs are looking to safe guard their own share price at all cost (ensuring investors do not look elsewhere for better ROI).

The week 8 - 15 August 2011, saw a spike in activity from multinationals such as Rio-Tinto, GSK and Vodafone all stepping up their share purchases (and re-purchases). Rio-Tinto in particular - purchasing £185m since Aug 4.

The Financial Times (Aug 13) stated that "buy back volumes on the London Market Rose from £329m in 2009 to £8.93bn this year" – a significant increase in a time of economic uncertainty.

With share prices falling so dramatically, this is a cost effective time for PLCs to reel in their public debt (while increasing the value of their own share portfolio – defending against hostile acquisitions) and perhaps look to the market themselves for potential M&A opportunities.

Ultimately re-purchasing shares requires cash up front and with a fluctuating (trending downward) economy – many are struggling to find enough liquid cash to maintain their core operations.

Procurement as an option?!
The crux of this conundrum is liquid cash – and how to get more. In response to the 2008/09 stock market crash, with research showing that 66% of costs incurred for UK businesses are procured, many senior executives focused heavily on controlling and reducing costs (both direct and indirect).

However, in many businesses, after 2009, the initial wave of cost cutting initiatives (reducing head count, closing stores, cutting budgets) was not sustained; they were done to release cash in the short-term and once the breaks came off, cost crept back into the business. Very few businesses actually looked to fundamentally change their expenditure patterns. 

This failure to address costs sustainably is now hitting business as we have strong signs of declining customer confidence and the need for another round of cost reduction is clear. Some heads and capex investments will no doubt be cut.

It feels like now might be a more fundamental time to make some more dramatic changes to the way that the cost base is run, particularly in relation to the biggest single cost, which is procurement. For the foreseeable future, revenues are not going to increase easily, and the problem with the easy cost cuts is that they simply re-appear.

Typically we are presented with two options when looking to increase cash liquidity:

• Increase top line revenues: Many PLCs are finding it difficult to significantly increase their top line (without incurring huge costs) given diminishing customer confidence and drastically reduced consumer spending (for Retailers in particular). 
• Improve bottom line performance: This implies taking cash straight out of the bottom line by starting with cash outflows first.

As an example based on the above 2 options - Company ABC, a Retailer with £100m annual turnover (with a net profit currently 10% of turnover and total expenditure of £80m) wants to increase profit by £1m, they could:

• Option 1, increase Sales by 10% (which they have been doing since 2008, without much success) OR
• Option 2, reduce costs by 1.25% – which is where procurement steps in.

By definition procurement’s role is to maximise cost efficiencies from the market place which can release some liquid cash relatively quickly, if done correctly. Negotiating a % off last year’s rate was always the key measure for procurement, but this very tactical approach can only last so long before the year-on-year savings figures diminish (similar to reducing head count or selling assets). The true value that procurement can deliver is realised  when procurement is involved at the start of a project (demand and specification definition) and not the end (negotiation and supplier selection).

The cash released through procurement’s cost reduction initiatives can be significant – if done correctly and approached strategically. For purpose of this post, Company ABC can now use this new available (liquid) cash to go back into the market and buy-back a large portion of shares at the current, relatively low, price.

I would be interested in hearing some real life examples of how you align and measure the performance of procurement against share value?

P.S in terms of share value protection, a £1m saving that procurement has brought to the table also has a direct impact on Market Capitalization, further improving Company ABCs share value in the market. Company ABC has a P/E (price-to-earnings) ratio of 15 – which means the £1m saved and banked as profit has just increased the MCAP of Company ABC by £15m.