Showcase Field: Capital Goods

Complex machinery and plants are usually procured by top management, as well as the development and engineering department. Buyers are just vicarious agents. However, they cannot only negotiate better terms but optimize the procurement process as well.

In 2009 and 2010, German companies had been rather reserved when it came to the purchase of capital goods. "In an economic crisis, that's where you'll save first because the old machine can still work a few more years", explains Jens Hornstein, partner at the consultancy Kerkhoff Consulting and co-author of the book "Investitionsgütereinkauf – Erfolgreiches Beschaffungsmanagement komplexer Leistungen". (Capital Goods Purchasing – Successful Procurement Management of Complex Services). On the other hand, production materials can hardly be reduced. Meanwhile, the German industry is vigorously purchasing again: The European Commission estimates that, in 2012, about 19 percent of the gross domestic product (GDP) will go to long-term economic investments. According to Kerkhoff estimates, every German company spends between five and ten percent of its procurement volume on capital goods.
Opinions are divided on what exactly counts among capital goods and how they are differentiated from other goods. "There are different definitions", says Hornstein, "it may even be a patent." The category basically includes all tangible and intangible goods which organizations procure to ensure the technical prerequisites for providing operational performance. Aside from patents, this will also include e.g. software for production planning. It thus no longer concerns only obvious capital goods, such as a production plant or a wind farm.
Unambiguous classification is important since it has a direct effect on the purchasing department. However, that department will be involved only at a late stage of discussions or even not at all. "Normally, executive management and engineering will decide on the acquisition of capital goods", criticizes Hornstein. So engineers will meet to discuss a new production line; and in the case of buildings, architects and construction companies will also sit at the table. In the rarest of cases, the purchasing department is invited to the meetings and only considered as a procuring agent. Yet, it could provide genuine added value for the company: For example, if a budget of EUR 2 million is available for a new plant, purchasing might possibly get it for EUR 1.5 million – with its knowledge of the market, its commercial know-how and negotiation skills. "This will require a strategic buyer", says Hornstein. He considers capital goods purchasing the showcase field. But the many years of just having been vicarious agents have left their marks – buyers are often not trained for strategic functions.
Yet, price alone is not what it's all about: "Unfortunately, many companies are primarily looking at the costs of procurement", explains Erik Hofmann, Professor of the Faculty of Logistics Management at the University of St. Gallen. At least half the total costs would go to energy, personnel, service, maintenance and repair, he says. Also, dismantling and disposal would frequently be forgotten in the calculations. They would have to be included into cost calculations prior to the construction. Even that would frequently not be sufficient: "There are services or performances which cannot be planned in the procurement stage", says Hornstein. For instance, when the service life is 20 years but a material defect appears after 15 years. Other risks must be anticipated as well: a construction stop, for example; or diminishing availability

It's not always necessary to have the luxury machine from the original equipment manufacturer
of specific materials which may result in yet higher costs. For such crisis scenarios, buyers must also develop financial scenarios. "Such a project cannot be realized without the purchasing department's comprehensive planning", says Hornstein. Yet, a new plant or system is not always necessary. "It's a waste if the new machine produces 2,000 instead of the formerly 1,000 parts per hour and that higher number cannot be sold on the market at all."
So when a technical department needs a production machine for injection molded parts, purchasing could clarify, for instance, whether the machine must absolutely come from the same manufacturer because it is integrated into other systems, or whether there are compatible machines which can usually be obtained at a lower price, or whether tender invitations would be worthwhile. "To be able to do all that, buyers need not know the technical matters down to the last detail", emphasizes Hornstein. In addition to General Management, Engineering, Development and Production, the Controlling and the Legal departments should also be at the table. Since the head of Engineering also considers himself the head of Purchasing, the social factor should be taken into account. "To avoid inter-personal problems, competent buyers are necessary who will show the engineers added values and relieve their workloads", says Hornstein.
Completed delivery does not mean that the buyers' work is done. Capital goods must meet a number of compliance guidelines, and that concerns Purchasing more than other departments. Clean, transparent procurement processes and reporting are an absolute must. However, there is a big gap between expectations or claims and reality: The Institut für Demoskopie (Institute for Public Opinion Polls and Research) in Allensbach thus interviewed 253 companies about the way they handle compliance and liability risks. The result: Nearly all companies connect purchasing with that subject – even before sales and financial departments. But more than two-thirds of those interviewed do not have any compliance management system or a code which would commit suppliers to follow rules. Even if a code exists, it shows up in the general terms and conditions (AGBs) of only one third of the companies.
Nevertheless, 67 percent of the companies have the code countersigned by their suppliers; and 86 percent of the companies check whether their suppliers comply with the code. Only one-fifth of those interviewed indicate that they are using country-specific codes. "They are true pioneers", emphasizes Frank Blasius, partner at the law firm Kerkhoff Legal which specializes in compliance cases, and co-author of the book "Aktenzeichen Einkauf" (Crime Watch Purchasing). Especially in view of child labor and environmental pollution, German companies can prevent being held liable for violations by their suppliers.
"Executive managers are highly interested in compliance", says Hornstein, "because they will be liable for ten years even if they have meanwhile left for another company." They will be liable even if purchasing is bribed. "Lawyers should accordingly monitor, as compliance officers, all contracts and processes, and they should warn executive management in good time.
Despite the risks, more than 50 percent of the companies indicate that they consider the introduction of compliance management in purchasing to be too expensive and too time-consuming. It's true that not every purchase will mean you'll have one foot in jail already "but sometimes buyers and executive managers don't know that their actions are illegal", says Blasius, "and any event of actual liability may push individual persons or an entire company to the brink of ruin."

• Kirsten Seegmüller
Free journalist in Leinfelden