Think about the concept of insurance.

Insurance allows you to recover from the unexpected.

If you get into a car accident, car insurance will pay for the repair of your car.  If your home catches on fire, homeowners’ insurance will pay for the replacement of your home.  If you get injured, health insurance will pay for your visit to the emergency room.

Sounds great, right?

Well, there’s a downside to insurance.  It costs money.

But, as evidenced by the gargantuan size of the insurance industry, there’s no shortage of consumers who consider the acquisition of insurance to be “worth it.”

Some aspects of procurement are like an insurance policy for a business.

If a spike in customer demand results in an unusual quantity of material to be used in manufacturing, a procurement decision to keep inventory in stock can save the organization from a stock out and lost orders.  If a strategic supplier facility gets destroyed by a natural disaster, switching to a well-prepared secondary source can save the organization from a partial or complete shutdown.  If cost certainty is a C-level priority, negotiating a fixed price with a supplier instead of a traditional index-based price adjustment clause can ensure that the organization maintains a predictable gross margin in volatile economic times.

What do these procurement scenarios have in common with insurance?

They all increase the likelihood that the organization can operate in a virtually uninterrupted fashion.

And they all have an incremental cost associated with that benefit.

More inventory increases carrying costs.  Using dual sourcing often results in higher purchase prices than exclusive deals.  Demanding a fixed price will often result in suppliers “padding” their prices versus giving them opportunities to fairly adjust prices in proportion to third party indices.

But accepting higher costs can be smart.  And can result in higher profitability in the long run.  Just like paying for insurance.

So, if you are ever in a position to defend procurement decisions that appear to have higher costs than riskier alternatives, compare your procurement work to insurance.  Know how much the organization pays for its various insurance policies.  And make the case that, just like spending $x on insurance for those other situations is smart, so is incurring slightly higher costs for the benefits of your “procurement insurance.”

Charles Dominick, SPSM, SPSM2, SPSM3

Charles Dominick, SPSM, SPSM2, SPSM3 is the Founder of the Next Level Purchasing Association. Charles is also the Co-Author of "The Procurement Game Plan: Winning Strategies & Techniques For Supply Management Professionals."

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