Recently I held a meeting with a customer to define a new strategy for buying energy. The company is a family-owned food producer that has recently witnessed strong growth under the leadership of a new generation of enthusiastic entrepreneurs. In terms of energy procurement we took many excellent decisions in the decade of our collaboration, such as leaving open an increasing part of the pricing to spot indexation in the recent period of price declines. Such decisions were based on the strong risk / opportunity optimization instincts that characterize strong entrepreneurs. However, as the company and its energy spend has grown, the owners feel the necessity of a more formal approach to eliminating risk due to energy market volatility.
During the meeting, we were surrounded by a management team of people trained in larger corporations. Confronted with the question of how much of the volume we leave open to spot price indexation, these professional managers quickly opted for the zero risk solution, meaning in their case that for all production for which sales prices have been agreed with clients the energy price would be hedged, leading to a freezing of the margins. The entrepreneur-owner protested against this, saying that he would feel sorry about the loss of opportunity if markets would go down. This was an excellent example of the tension between entrepreneurialism and a more managerial approach to business and the way it can manifest itself when buying energy.
As companies grow, it becomes impossible to run them based on the enthusiasm and strong instincts of their entrepreneurs. The necessity for more managerial skills grows. In the buying function of a company, procurement professionals are hired and they introduce more structured approaches to buying. Systems are introduced that can track an invoice back to a procurement decision (purchase orders). Decision power is attributed and the authority to purchase is taken away from the users of the goods and services that are bought and delegated to the professional buyers. Formal contract negotiation procedures such as RFQ’s (request for quotations) and RFI’s are introduced. In commodity buying, risk management or other approaches to fixing volatile forward prices are set up. Often, the success of this introduction of professional procurement is measured in terms of savings, which can lead to the introduction of complicated systems for savings calculations.
In many cases, energy is one of the last categories to be brought under formal control. Many companies consider it to be a highly technical category and leave it for a long time with the maintenance or facility management professionals. There is no reason for doing this. Buying energy in an open market is much more challenging from an economic-commercial point of view than technically. I’ve never witnessed a company doing an awful job at energy procurement because its staff members failed to grasp the subtleties of MWh’s versus MW’s. But I’ve seen many companies failing at buying energy because of a lack of understanding of how commodity markets work. Therefore, introducing professional procurement management methodologies can be a blessing for a company’s energy buying practices.
However, too much management techniques can easily derail in a too formalistic approach. Entrepreneurialism, that usage of passion and strong instincts to take the right decisions, disappears and gives way to corporate bureaucracy. I recently had a discussion with the energy buyers of a client of ours, one of Europe’s largest corporations. In this company, a strong procedure for running tenders has been developed that should ensure that the company is always making the best out of the market. However, running this procedure is so demanding that the buyers prefer running bi-annual rather than annual tenders, which would give them better protection in terms of wholesale price hedging. In its worst form, the procurement division becomes a corporate bureaucracy where the instrument of running formal procedures becomes a goal in itself, rather than making the best out of the markets. The system for savings calculations, for example, can easily start to live a life of its own. One client once told us that the first thing their new CEO said in a meeting with the procurement division was: “I want you to stop reporting savings. Why? Well, if all the savings that you guys and girls reported in the last five years had materialized, we would now be paid by our suppliers”.
It’s logic that entrepreneurs that are introducing formal management in their companies revolt against such a bureaucratic approach to procurement. Corporate excellence isn’t founded on “just following the procedures”. A good energy procurement practice will strike a good balance between the professionalism of good procedures and leaving room for talented individuals to take good decisions:
- Good data management is an indispensable starting point for professional procurement. You can’t be successful at buying energy if your information is stuck in the heads or on the local hard disks of hard-working staff members. However, you should consider efficiency when setting it up. One client once told me that he spends about 70% of his time on internal reporting. Imagine what it would mean for his company if he could bring this down to 40% and actually double the amount of time he has for being informed about the market.
- Giving some structure to your contract negotiations will make them more effective. However, take into account that energy companies have to produce a lot of offers. If your RFQ procedure becomes too demanding, the account managers might lose their enthusiasm for doing the deal because they have to deviate too far from their standard procedures for making offers. Also, leave some room for good old negotiation. I see many large corporations that go into the market with RFQ’s that are already asking for all the concessions that they want to get. They will get them, but at what price? Negotiating concessions is a much better methodology than writing lengthy, demanding RFQ’s.
- As a larger corporation, you can’t have the fate of your energy spend determined by the gut feeling of your energy buyer(s). Setting up a good risk management strategy can make sure that nobody will take decisions (or not take decisions) that damage the company. However, within the framework of such a risk management strategy, you should leave room for some opportunistic decision making.
Savings reporting can be a good tool for measuring the success of your energy buyers’ entrepreneurialism when buying energy. However, it isn’t always easy in energy to determine which savings are due to an action by an individual and which are just due to changing market circumstances. But that’s a topic for a new blog article.