Sunday, April 25, 2010

Where are we on the cycle?

The stock market is strong with low volatility as we enter earnings season. The link between weak dollars and higher stock prices seems to have been broken, as the stock market's latest climb has occurred despite a strengthing greenback. Business growth is beginning to show positive developments, and inflation appears to be under control (near term) despite massive state, federal and foreign country budget deficits. Housing markets seem to have hit bottom in most locations and inventories are starting to shrink, albeit at lower prices. The new normal, right? So what's wrong with this picture?

If you're a buyer, not much. Unemployment remains relatively high, and is a lagging indicator. Wage rates are still soft, and services categories which have higher percentages of labor costs in the total cost equation can still be competitively leveraged. However, commodities have really firmed. I always watch the copper market, more so than energy, and use this as a leading indicator of economic activity. My assessment is that it's time to go long in services.

Most companies buy services along an annual cycle based on budgets, and this is a mistake. There can not be a better time for locking in longer term arrangements in services categories where you have already leveraged prices and benchmarked the marketplace. Some do it by adding option years to their contracts, exercisable at the company's option. Others do it by making longer term commitments up front with 3 year contracts plus options to extend. There are plusses and minuses to all of these.

The real secret is to understand your business strategy. If you need the supplier to offer up ideas for competitive advantage and dedicate R&D resources to supplement the supply relationship, are they more likely to do so under a longer term arrangement, or one in which you can cancel with 30 days notice and annual options to renew? Under the long term arrangement, how can you drive toward continuous improvement and create metric-based incentives that counter the potential for complacency, or being assigned the B or C team to your account? How do you create a true strategic relationship whereby both parties put skin in the game, share risk, and have an opportunity for reward as well?

In all of this, the challenges may be more internal in your organization than external - the contracting strategy has to be in sync with the business strategy, and if it is, you can usually overcome the budgetary constraints to contracting. These business cycles are long, and when things firm up, they usually happen in a hurry. Act now, while you still have timing in your favor.