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 This Issue—Volume 1, 2007
 
  Greetings and Happy New Year! Even though we have every intention of publishing this newsletter on a monthly basis, we sometimes get sidetracked. Nevertheless, we kick off our ninth edition of Gunpowder with some practical sourcing advice with a column by Spend Matters blogger, Jason Busch. Our European correspondent Stuart Burns pontificates on why middle market manufacturers often fail to implement identified cost savings. Last, Lisa Reisman tackles a heady subject on quantifying the cost of quality while making sourcing decisions.

Disagree with us or got an idea for an article? Let us know: info@aptiumglobal.com.

 
 
 

Three Top Sourcing Tactics for 2007

Rather than come up with predictions for 2007—which everyone else is doing, and I've done already on an upcoming podcast—I thought I'd share with you what I believe are some of the sourcing tactics that companies who get ahead in Spend Management next year will deploy. And I won't bore you with deep thoughts such as how "multi-attribute auctions" and "optimization" techniques can help you save an additional 5%. Yada yada yada ya. No, these suggestions—at least I hope—will be a bit out of the box. Let's begin.

First, I would suggest that more sophisticated Spend Management organizations will increasingly take a trading perspective to sourcing in an effort to model upside and downside risk. This will involve separating out and analyzing all of the total cost elements—via cost break down worksheets pre-bid—of truly strategic buys and taking advantage of various elements that comprise total cost.. What do I mean by this? It's not just about hedging downside risk. Rather, this approach is about looking for areas where suppliers are miss-pricing underlying contract component elements—or are openly willing to trade less favorable terms for the business other than their quoted price.

For example, by creating sourcing strategies that separate out such areas as currency, logistics, freight, and import costs—and adding them back in, to see how suppliers price them—smart procurement organizations will discover even better total cost solutions than before, trading on true market and pricing inefficiencies in their supply base. Just as hedge funds made a killing in the early days by exploiting market inefficiencies in the pricing of currencies, equities, debt and derivatives, advanced procurement organizations will do the same by going after the same inefficiencies in supply market quoting, taking advantage of supplier mistakes in underlying contract pricing elements (other than just basic unit cost)

Second, sourcing and procurement organizations who align their own objectives—or MBOs, if that's the driver of performance evaluations—with the right set of corporate metrics and goals will deliver greater value. To give a real-case example, in volatile commodity areas, these up-front goals might be to minimize downside risk rather than maximizing short-term savings potential. Hence, quantifying and measuring both actual savings and cost avoidance based on metrics that role up to the business is absolutely key. I can promise you that as the year starts, if you spend a few weeks creating a shared vocabulary and definition of goals between procurement and the business, it will more than pay off. And in doing this, I would suggest placing just as much emphasis on cost avoidance—or risk minimization—as classic savings measures.

Third, take supplier rationalization strategies a step further. Don't just reduce your supply base and competitively negotiate more spend—take a keen interest in developing your strategic suppliers, not just to reduce risk, but to reduce costs. For example, take an active role in negotiating and locking in pricing for their commodity items and spend (such as metals, energy, etc.) related to your production. And invest in parachuting in Lean and Six Sigma teams to reduce waste, rework, and inventory. And make sure your suppliers have got standard sourcing systems and processes in place so that once you leave, they'll be able to continue to drive additional savings opportunities (heck, if your licensing allows it, give them access to your Spend Management tools and applications, and agree to share in the savings that result).

I know I said that I'd offer up three sourcing tactics, but for the sake of paying some lip service to indirect and services spend categories—which I should have done earlier in this post—I'll even give you a fourth. And this piece of advice is to bridge the gap between savings identification in indirect and services spend categories and savings capture. By this, I mean that it's critical to ensure that the frontlines of the business can easily access negotiated pricing and terms. To make this happen, it's critical to make sure your e-Procurement system covers as many categories and suppliers as possible. And invest in frontline solutions like Rearden commerce for T&E and services spend categories. I can't emphasize enough that implementing indirect and services savings can be as challenging as unearthing savings opportunities in the first place. And it should be procurement's role to make the savings capture of indirect and services real, not just theoretical.

Jason Busch is Managing Director of Azul Partners and writes the acclaimed Spend Management blog www.spendmatters.com.

Why do firms fail to implement clearly defined cost savings?

External partners are privileged to have a bird’s eye view of a client’s supply chain and business functions. This third party relationship provides a slight detachment which allows one to evaluate the risks and opportunities in a dispassionate and more analytical manner. Given this outsider perspective I thought it might be interesting to share some thoughts on why some firms in the middle market enthusiastically implement the results of cost reduction programs while others can take months to arrive at the first trial order or at best only make partial implementations.

Probably the most critical element is clearly defining cost savings. After all, cost savings are nothing but a pile of sand if the savings are not universally accepted across the management team. So the first priority should be to have a clearly defined baseline for measuring the savings and a process for reporting them on a regular, usually monthly, basis. But if only it were this easy—for example establishing baselines in a fluctuating commodity market is at first sight an almost impossible task. However, if the underlying commodity prices can be identified then even complex mixes of products like foam or plastics can be tracked and the value add stripped away from the commodity costs.

Assuming that the baseline and monitoring process has been accepted by all parties, it should be clear sailing to implement and measure the cost reduction accruing to the bottom line, right? Well no, the more highly engineered the product the greater the impact on Engineering, Design and/or Production. It is not uncommon for savings of $30–40k month to be held up because Engineering or Production does not have the resources to evaluate the impact of the change. In one case we’ve observed, this was recognised early on as a bottle neck and external resources were hired to run the evaluation and quantify the changes required. Unfortunately, too often clients forego the benefit of the cost reductions while they wait for an in house evaluation moving at a “we’ll fit it in when we can” pace.

Many companies will run their own Low Cost Country Sourcing projects and identify hugely more attractive ex-suppliers-factory-gate prices from an overseas supplier but still fail to either capture those savings at implementation or convert that low supplier’s price to an acceptable delivered client’s works price. This often comes down to a failure to properly account for the total landed costs, the sea freight, customs duties, in-land freight, finance, foreign exchange and quality control issues. These issues highlight the value of bringing in outsiders to embed the processes and controls. Companies often blame their LCCS suppliers for these problems when the real problem is the approach.

But more often than not, when there is a failure to implement the savings it is often due to a failure from upper-management. The failure to implement tends to be systemic starting at the top and moving into the collective culture of the enterprise as a whole. In a troubled organisation, departments look to their own immediate priorities rather than identify with entire company’s priorities. The most successful companies are those where all parts of the organisation have a margin centered focus and are willing to subjugate their own departmental priorities for the greater good. For example for a purchasing department to change a supplier is an involved process. There is a considerable amount of work required in setting up new supplier records, establishing payment and returns policies, running down inventory and juggling both suppliers while the new one ramps up production.

Furthermore, relationships have formed over many years of cooperation and can feel like parting from a friend if a change in supplier is required (even though that friend may be costing the organisation dear). Those outside of purchasing don’t see this work load or experience the anxiety that comes with change. It’s hardly surprising that purchasing departments are reluctant to change suppliers. In fact the whole process illustrates why there has to be incentives to create a culture willing to embrace change. In larger organisations, the growing prominence of the CPO is an example of how important the once neglected purchasing role is becoming. There are lessons here for the middle market in both the selection of high quality individuals to run this crucial function and bringing the purchasing teams into the broader corporate objectives of improving margin and growing profitability.

Stuart Burns is Managing Director of Aptium Global where he leads the firm's practice in Europe and Asia.

The following article originally appeared in Sourcing Innovation, on January 3, 2007. It has since been modified.

Quantifying Quality in Lean Sourcing Initiatives

I’m sure that a good number of readers are familiar with the basic concepts of lean manufacturing, which is all about eliminating waste and removing any steps in a process for which a customer would not explicitly pay for. But even more readers of this readers are schooled in the art of strategic sourcing.

Lean Sourcing blends both lean and strategic sourcing. In our view, the result is total enterprise cost reduction, as opposed to line item or category cost reduction which typically does not include many operational and quality factors that add costs outside of procurement. If you aren’t measuring quality from your supply base, you aren’t practicing Lean Sourcing.

Many organizations use supplier scorecards—but few really establish baselines of performance from their incumbent suppliers. The reason incumbent suppliers typically win “bids or ebids” is because buying organizations think they have a good handle on quality. Or, they choose to deploy the “I’d rather work with the devil I know vs. the devil I don’t.” But if you don’t measure, you don’t know. And if you don’t know, you have no idea if your current vendors are your lowest total cost suppliers.

From a Lean Sourcing perspective, at a minimum, companies should deploy a scorecard which measures the following: Material Acceptability (NPT’s—Non Conforming Product Tickets Issued), Quantity/Purchase Order Reliability, Timeliness, CAR Response time (Corrective Action Request), Packaging. These metrics certainly cover the basics. But the question becomes: how do companies use this data to weight suppliers when making award decisions?

Many companies use the scorecard for on-going quality assurance and certainly as a means for addressing potential problem issues. But few create a linkage of supplier quality and performance as a factor into sourcing decisions. True, most sourcing platforms take into consideration quality elements (e.g. most platforms allow the buyer to “weight” quality performance parameters). In the real world, however, many of these methods end up being quite qualitative and in some cases, arbitrary. Let’s face the facts—buyers like to use their incumbent suppliers not only because they have a relationship with them but because they feel their operations folks are content and/or pleased with the quality levels received from their current suppliers.

But let’s take a look at this in a little more detail. Automotive companies rely heavily on PPM (or Parts Per Million) or DPMO (Defective Parts per Million Opportunities) data. By requesting a new supplier’s external PPM number, a sourcing professional can begin to short list potential suppliers. Many automotive suppliers will not even consider a potential new supplier who is not under 49 PPM.

The truth is that while many companies claim their suppliers have excellent quality, when one really examines the data over a 12 month period, the numbers often tell a different story. From a supplier scorecard perspective, in the case of low cost country sourcing, it is not uncommon to receive a couple of defective parts per shipment. These defects can begin to add substantial cost quite quickly. More sophisticated organizations have conducted activity based costing analyses to quantify the cost of poor quality from every step within the production process. Of course an error caught earlier in the process (e.g. during incoming inspection) is a lot cheaper to correct than identifying an error caught later in the process say after production (e.g. when the part would likely need to be re-made).

In our view, manufacturing organizations of all sizes can better incorporate quality into the sourcing process. As a foundation, we recommend:

  1. Implementing supplier score-cards, and at a minimum, tracking every shipment using the 5 metrics discussed above. If you have been using supplier scorecards already, good for you! Quarterly or semi-annually, sit down with key suppliers (when possible) and review key operational metrics such as PPM. Understand and establish a quality baseline for current suppliers.
  2. Communicating to your supply base your quality intentions. For example, if you are in the automotive industry, you are probably being told by your OEM customers that you need to be shipping 0 ppm parts. Hold your supply base accountable to the same standards.
  3. When deploying sourcing initiatives, look at your largest categories by dollars and by quality and focus Lean Sourcing efforts on those categories where your cost of quality has eroded organizational cost savings on a total cost basis.

If you want to dig further into the concept of Lean Sourcing and how it can reduce your total enterprise costs, please go to download it here.

Lisa Reisman is Managing Director of Aptium Global where she leads the firm's practice in North America.

 

   

 

This newsletter is published by Aptium Global Inc a direct material advisory firm based in Chicago, IL. With offices in the UK, China, India and a network of global associates, Aptium Global works with small and medium sized manufacturing companies to save money on direct material purchases. Smaller companies face the same cost pressures as the Fortune 500, yet often lack budgets for cost reduction services. Aptium Global works with organizations on a pay-as-you-save™ basis, minimizing impact on cash flow and maximizing impact on the bottom line. We aim to publish this newsletter on a monthly basis but reserve the right to miss a few deadlines here and there.
 

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