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Strategic Supply Management at Pacific Gas and Electric Company

Author(s):

Richard L. Pinkerton, Ph.D., C.P.M.
Richard L. Pinkerton, Ph.D., C.P.M., Chair and Professor of Marketing and Logistics, The Sid Craig School of Business, California State University, Fresno 93740-8001, (559) 278-7830, E-mail: richard_pinkerton@csufresno.edu

Kevin J. Dowd
Kevin J. Dowd, Director of Purchasing, Pacific Gas and Electric Company, 123 Mission Street, San Francisco, CA 94105, (415) 973-2661

84th Annual International Conference Proceedings - 1999 

Abstract. This is the case history of how one of the nation's largest privately owned utilities, Pacific Gas and Electric Company (PG&E) in San Francisco, changed from reactive purchasing to strategic supply management. Starting in 1993, PG&E established partnerships with key suppliers, consolidated purchasing from the field and negotiated long-term contracts based on total cost of ownership. This paper will summarize the major policies, procedures, and programs instituted to achieve strategic supply chain management.

A Short Profile of Pacific Gas and Electric Company in San Francisco, CA (PG&E). Founded in 1852 as a traditional energy "public utility", PG&E corporation provides gas and electric services to northern and central California and is one of the nation's largest investor owned energy-based holding companies including: PG&E Company, U.S. Generating Company, PG&E Gas Transmission, PG&E Energy Services, and PG&E Energy Trading. In 1997 operating revenue was $15,400,000 provided by 21,000 employees. Since 1996, PG&E Corporation is a combination of regulated and deregulated operations, however, this paper focuses on the purchasing operations of PG&E Company as it competes in the newly competitive energy market. Please note that PG&E Company is still regulated by the California Public Utilities Commission (CPUC) which reviews and authorizes specific financial earnings based on approved costs. Hereafter, the company will be simply referred to as PG&E.

The Beginning of Strategic Supply Management at PG&E. In July of 1993, PG&E published a document called "CES Investment Strategy: Procurement II Project summary." Based on the combined work of Bain Company, a leading consulting firm, and PG&E analysis teams. A major finding in their report defined a world class (benchmark) purchasing organization as one which:

• Separates strategic and tactical purchasing activities
• Uses cross-functional commodity teams to leverage expert knowledge and integrate field concerns into purchasing decision making
• Forms alliances with a few key suppliers to assure the success of both enterprises
• Makes purchasing decisions based on lowest total cost rather than price
• Conducts regular internal and external benchmarking to monitor and improve performance

This paper will highlight the progress made over a five-year period to achieve these goals. Anyone familiar with a huge utility will appreciate the enormity of this task, somewhat like trying to turn the Titanic to find open water and miss the icebergs. The following actions are not in any particular order in terms of sequence or importance.

Value Managed Relationship (VMRs). Cross-functional terms including purchasing, engineering, operations, and suppliers developed eight key VMRs which consolidate at least eighty percent of selected critical and high value purchases to single suppliers who typically have three-year contracts. (Although one has a ten year contract). The selected suppliers were all previous suppliers of long standing and both sides had to agree to doing business based on: open communications, sharing schedule data, documenting life cycle costs with the requirement by the supplier to constantly improve quality at lower costs and most important, awards would be based on negotiations and trust as opposed to traditional competitive bidding. These VMRs include: distribution transformers, cable, power transformers, and negotiations are now being conducted for steel gas pipe and power circuit breakers. A few VMRs purchases total $40 million per year and are obviously "A" inventory items. Most of the VMRs started in 1996-97.

All VMR suppliers visit PG&E purchasing headquarters in San Francisco at least four times a year for a formal review of contract progress including status reports regarding issues, orders received, specifications, quality, logistics, pricing, and management. For example, defects per thousand, dollar savings, and pricing compared to the CPI and PPI are reported and analyzed.

Utility Distributorships. Huge expenditures in pole line hardware, gas fittings, and plastic pipe have been consolidated to just three major distributors for the above material. Proposals prepared by cross-functional teams were sent to leading distributors and responses were then analyzed and rated on weighted scales for pricing and life cycle costs, services, delivery, stocking capacity, quality, and management experience and skill. Six finalists for each contract were invited to make an oral presentation to the teams prior to the final awards of one-year renewable contracts. It is anticipated that with good experience, these contracts which started in 1996-97 will be multi year, probably 3-5 years.

Integrated Suppliers. These are typical MRO type distributors operating under what has been traditionally described as ""system contracts for families or groupings of related products." They include: office supplies, industrial supplies, uniforms, telecom, safety, and tools. Pending contracts include: printed materials, signs/labels/decals, rainwear and promotional items. For the most part, these suppliers have one hundred percent of the purchases within each category and again, contracts are negotiated by teams. These supplies stock material and manage the inventory for both the users and the manufacturers.

Service Contracts. This is a difficult area to consolidate and to negotiate total life cycle costs versus price. For example, in 1997, PG&E trimmed about 2.1 million trees in a 70,000 square mile area using 30 contractors. While two major contractors completed the majority of the work, it remains to be seen if either can or should be given more of the contracts. Is any single supplier capable of supervising and doing this enormous ongoing vegetation management project, which includes three major tasks; pre-selection, cutting-removal and post inspection? The potential for cost savings is obviously large as PG&E spends approximately $150 million a year to protect against vegetation related power loss plus personal and property damage. A vegetation contract team is hard at work on this issue, which includes managing the trimming of 5,000 trees a day.

The Red Team. The red team is a group of buyers and supervisors who have advanced negotiation training. They operate under a formal written purchasing policy and typically include a buyer, end-user and other required specialists such as engineers. A supervising buyer serves as the red team leader. The red team is involved in any negotiation which is $500,000 or greater in value and is designed to ensure that professional negotiators are involved in major purchases.

Supply Partners Achieving Real Quality Program (SPARQ). Consultant Chip Long of Seal Beach, CA devised a unique rating system of monthly supplier performance report cards based on:

Quality (receiving, field failures)	40 points
Delivery (On-Time, Lead Time)	30 points
Cost and Service (Cash Discount, blocked invoices, EDI, bar-coding, unresolved claims 30 days)	20 points
Supplier Diversity	10 points
Total	100 points

To win a gold award over a 12-month period, a supplier must earn 98% of all points, to become a silver supplier, 90% and a bronze supplier, 85%. We call it the PG&E Olympics. Awards are made at the annual supplier awards day held at the PG&E learning Center in San Ramon, CA. The last event was held on January 22, 1999 and included a keynote speaker. This one-day program also promotes informal discussions during breakfast and the celebration reception. By the way, all key suppliers are invited to this function.

Smart Spending Program. One must remember that the utility operation of PG&E is still under the regulation of the California Public Utility commission (CPUC). CPUC mandated a ten- percent electric rate decrease for all residential and small business customers in California (effective January 1998). The Smart Spending Program is a direct response to this decree and targets all aspects of PG&E with specific cost reduction goals. Obviously, purchasing is the major player in this program.

Supplier Diversity. In 1997 CUPC mandated that 20% of all purchasing dollars go to minority-disadvantaged owned and operated suppliers. This becomes part of every buyer's goal and yearly purchasing plan. Such a goal calls for real sourcing skills, which is also reflected in the SPARQ Program. Three specialists assist the Purchasing Department in achieving this task.

Quarterly Client Satisfaction Surveys. Every quarter, clients or end users with PG&E are surveyed by questionnaire on their experience with the Purchasing Department. The criteria include: knowledge/expertise, client focus, timelines of deliverables, communications with the client, service value and service quality. The overall satisfaction scores have been very high, i.e., 4.3 out of a maximum of 5.0. Teams for contracts, electrical and mechanical, field buyers, integrated supply, logistical planners, and policy, programs and support personnel also compile ratings.

Policy Development: Two Step Negotiation and Total cost of Ownership (TCO). As noted in the 1993 benchmark by Bain Company and PG&E teams, it was apparent that the historical use of straight government style competitive bidding with its inherent focus on price (common to most utilities), would have to change. This requires an ongoing evolution of policy-procedure development to the two step supplier selection method which involves a first call for proposals and then a second round of negotiations with the selected "finalists" which considers all aspects of the contract including TCO.

PG&E is still developing policies for both procedures with specific guidelines for determining first cost (price), process cost (administrative cots to procure a product or service such as EDI) and lifecycle cost (maintenance, training, inventory, defects, salvage, etc.). TCO includes both cost reduction and cost avoidance, but the savings methodology must be carefully defined along with formula, rules, worksheets, and other guidelines. It is very difficult to calculate TCO for services and several teams are still working on this area of application.

Training. Procurement programs at the University of California at Berkeley Extension and California State University, Haywood, were established. Strong incentives to achieve Certified Purchasing Manager (C.P.M.) status were also instituted. In addition, special in-house programs in negotiation and price cost analysis are regularly conducted at the PG&E Education Center. While most buyers believe they are good negotiators, most are not and continuous and rigorous training is mandatory. It is one thing to select (or accept) the lowest bid, it is quite another and a far more sophisticated undertaking to negotiate a win-win agreement.

In addition, the SPARQ consultant holds regular coaching sessions and buyers are encouraged to attend evening/weekend relevant degree programs. A professional development manual also offers specific guidance on a wide variety of learning resources including books, tapes, seminars, and NAPM educational resources.

Legal Review. Historically, many utilities have engaged in detailed legal review of contracts which delays the contracting process and often inserts "unconscionable" or take it or leave language into the contract rather than relationship or partnership terms. The regulation of utilities by public commissions and heavy potential (real and imagined) legal liability inherent in utility operations are understandable reasons for this historical extreme legal review. PG&E now has an informal team reviewing the legal review policies with the objective to reduce this time consuming and often, unnecessary step in the procurement process.

Internal Surveys of Buyers, Clients, and Suppliers. In April of 1998, the consulting author of this paper conducted 70 in depth personal interviews with the principal partners to be a supply contract, i.e., the buyers, clients (end users), specification engineers, managers, etc. and key suppliers. These interviews were designed to gauge progress against the 1993 PG&E benchmark study and current objectives. This survey was also designed to review policies, procedures and to actually participate in negotiation planning. The results of this survey indicated good progress was being made but as in any re-engineering, certain gaps, problems, and additional opportunities called for specific remedial action. For example, there is not enough early supplier involvement on teams, and there are insufficient funds for buyer visits to supplier operations. We cannot over emphasize the importance of regular and objective reviews of progress.

Organizational and Reorganization. Since 1993, four major reorganizations have occurred, somewhat normal for a huge operation, and purchasing now reports to the Vice President of General Services. While it is organized around commodities (electrical/mechanical components, services, integrated suppliers), it is split into strategic and tactical operations. The purchasing department goals are:

1. Strengthen the role of purchasing as functional lead for contracting and procurement services (centralized-consolidated purchasing).
2. Improve use of strategic sourcing (VMRs, integrated supplies, etc.)
3. Drive costs out of the procurement Chain
4. Maximize opportunities for WMDVBE (minority - disadvantaged) suppliers.
5. Increase expertise and professionalism within the department.
6. Establish safe work practice.

Results to Date. Aside from the specific programs outlined above, the documented savings for the first quarter 1998 of the integrated supply contracts, as just one example, totaled $2,904,764 for 1998-99. In addition, p cards, y2k review programs, web page sourcing, and other such projects are all making major contributions. The VMR and SPARQ programs are excellent examples of strategic supply chain implementation. As we conclude this paper, it is well to note that the road to strategic supply chain management is neither easy nor fast. It involves a methodical evolution, not a revolution.

REFERENCES

Burt, David N. and Michael F. Doyle The American Keiretsu: A Strategic Weapon for global competitiveness, Homewood, Illinois, Business One, Irwin, 1993.

Burt, David N. and Richard L. Pinkerton, A Purchasing Manager's Guide to Strategic Proactive Procurement, New York, New York, Amacom, Division of the American Management Association, 1996.

Riggs, David A. and Sharon L. Robbins, The Executive's Guide to Supply Management Strategies: Building Supply Chain Thinking into All Business Processes, New York, New York, Amacom, Division of the American Management Association, 1998.

Handfield, Robert B. and Ernest L. Nichols, Jr., Introduction to Supply Chain Management, Upper Saddle River, New Jersey, Prentice Hall, 1999.

Long, Chip, and Gay Meryer, Sacred Cows Make the Best Barbecue, Supply Chain Management: A Revolutionary 26-Week Action Plan, Vision-Press, P.O. Box 3417, Seal Beach, CA 90740, 1998.

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