Return to Gunpowder
 Welcome to Gunpowder!

We thought the name Gunpowder might get your attention. We chose it because of its explosive and medicinal properties. Medicinal you might ask? Gunpowder is a green tea whose leaves are rolled into pellets. If you believe in Chinese medicine, it can prolong life, reduce the risk of cancer and lower cholesterol. With this newsletter we hope to share some pellets of information if you will, to help organizations heal themselves of rising cost structures by reducing their direct material costs. As for explosive, we promise no marketing or sales pitch—just hard-hitting examples, case studies, articles on procurement trends, interviews with industry experts on cost reduction topics and a mailbag (we’ll even print your negative letters). Your thoughts and ideas on topics are of course, welcome. You can even whine to us about how outsourcing is destroying the American way of life. But we might remind you that your shareholders share a different opinion.

 This Issue—November 2004
In this launch edition of Gunpowder, our editor, Lisa Reisman tackles pinning down negotiation strategies in tight commodity markets…if steel prices have you down, Lisa offers a few strategies. From our UK desk, Stuart Burns offers his advice for taking that offshore sourcing plunge. Finally, we conducted a brief interview with Jason Busch, formerly of FreeMarkets, on technologies that matter to the small and mid sized firm!
Selecting Negotiation Strategies
in Tight Commodity Markets

There is nothing more annoying to any business executive than to feel as though there is no leverage to be had with one’s suppliers! In reality, in tight commodity markets there are a range of tactics that small and mid sized businesses can deploy for either cost avoidance or overall cost reduction. But companies often do not understand that the very nuances between the products and materials that they are purchasing lead to very different negotiation strategies.

Let’s step back and examine three primary negotiation strategies:

PartnerLike the word suggests, this strategy dictates a closer relationship, particularly when the product must meet critical delivery schedules, or when a supply market for the particular part or commodity can be considered monopolistic. Partnering involves “opening the books” and working together to identify areas for total supply chain cost reduction.

Bid via auctionThis is what it sounds like but auction(s) tend to be in reverse; that is suppliers bid the price of the material or commodity down. This format tends to work best when there are at least half a dozen suppliers. Supply markets with over 12 qualified bidders ensure the best results.

One on one negotiationThis type of negotiation works well when there are a limited number of suppliers for a particular product or commodity (e.g. not a monopoly but not enough participants for an auction) or, the dollar amount of the spend category does not represent enough volume to run an auction event.

An example helps to illustrate the different scenarios. An automotive supplier buys both aluminum sheet and steel stampings. These both sound quite similar (they are, after all, part of the same commodity familymetal), but each requires a different negotiation strategy.

A commodity like aluminum sheet (e.g. 1050 H14 .080 ” x 48” x 144“) might be supplied by dozens of different companies, however, because it is a commodity (or near commodity), the price range of this product typically falls within a small band (e.g. it is unlikely that one supplier will be grossly cheaper than another supplier). The strategy to source this item is a one on one negotiation with various qualified suppliers. The advantage achieved by the automotive supplier will involve identifying a larger number of qualified potential suppliers and comparing pricing, quality and delivery information.

A steel stamping, though commodity like in nature, actually is a bit more complex than the aluminum sheet because of its greater percentage of value-added content (sorry for the hackneyed, clichéd term, but value-added really refers to something herethe production process used to transform the semi-finished material into a stamping). This would include the stamping process and potentially welding, assembling, punching or coating. These value-added processes, because of their higher labor component, provide an opportunity for cost savings and potentially, a reverse auction. Moreover, there tends to be dozens of potential suppliers of these types of products. Creating an online competitive bidding situation often yields better results than traditional one-on-one negotiation or a partnering strategy.

Typically, categories such as metal parts, electronics and plastic parts make for good auction candidates. More commodity-like products such as chemicals, food or steel and raw metals do not make for good auction candidates.

For companies new to the auction arena, there are a few risks that should
be considered:

Auctions—Risks:
• Limited control (of supplier behavior)
• Can expose more information about the company or its parts/materials
to a broader supply base
• Auctions can upset incumbents

At the same time, using one-on-one negotiation instead of an auction format also presents several risks.

One-on-One Negotiation—Risks:
• It is possible that the “best” supplier is not part of the process (too few suppliers)
• Potential exists for “the relationship” to influence award decision—it takes the neutrality
away from the process

While there is no reverse auction panacea to sourcing in tight commodity markets, companies that take the time to strategically examine their various spend categories, aggregate spend to increase volumes, gather supply market knowledge, and implement the right negotiation strategy stand to reap significant cost savings, even in tough sourcing environments.

Lisa Reisman is Managing Director, US Operations, Aptium Global Inc. She can be reached at 773.525.9750
or by email at
lreisman@aptiumglobal.com.

Crawl, Walk, Run—How Global Sourcing Programs
Really Get Implemented

Implementing a global sourcing program might sound unconvincing to manufacturers that have spent years developing long-term relationships with their domestic suppliers. Quality, convenience and reliability are the trademarks of these types of relationships. To further complicate matters, moving tooling or building new dies, adding buffer stocks, and establishing foreign currency hedging is enough to scare off even the boldest of companies.

So how do manufacturers make the move offshore?

Our research and experience suggest that for more complex goods, the most effective strategies often involve a phased approach over a longer time period, perhaps even years rather than moving all sourcing offshore in one step. How does this work in practice? Let’s examine what a typical phased approach might look like. For example, consider a Tier 1 automotive firm who is currently purchasing steel stampings from the domestic market. As part of the relationship with its customer, the Tier 1 firm is the “steward” of the tooling, meaning though the tooling is owned by one of the Big 3 auto manufacturers, the Tier 1 firm has some say as to where the parts can be produced.

The first phase of the sourcing strategy would involve primarily domestic suppliers but also introduce a limited number of low cost country suppliers into the bidding process. During the contract award process, the Tier 1 firm decides to give the entire contract award (volume) to a domestic supplier. But as soon as the first order arrives, the Tier 1 firm begins to identify low cost country suppliers in SE Asia or Eastern Europe, some of which may have already been involved in the bidding process during phase one. At the same time, the Tier 1 firm receives price quotations on the costs of developing a second set of tooling. The tooling costs for dies produced in Asia and Eastern Europe are expected to be amortized and rolled into the piece part price over a two – four year time span as some supply begins to move offshore. In year two, after a competitive bidding event, the Asian or Eastern European supplier receives 25% of total spend while the domestic supplier receives 75% of total spend. In year three, both sources of supply receive 50% of the volume and the Tier 1 firm can decide in years four and five the proper mix and volumes for each supplier, depending on the Tier 1’s annual “give-back” to the automotive OEM.

From a negotiation standpoint, this strategy works well when there is more than two million dollars in annual volume. At one million dollars of annual spend, the volumes are interesting to both Asian/Eastern European and domestic suppliers. With two or three million dollars in annual spend, the Tier 2 firm has enough volume to make the contract attractive enough to both suppliers, while still maximizing volume discounts.

Though in many situations, buying organizations would rather rationalize their supply base, reducing the number of suppliers, in this case, because of the stamping complexity and quality requirements, it actually makes better sense to fully develop two suppliers. By following such a program, the Tier 1 firm actually reduces their supply risk by developing a second source of supply while simultaneously establishing an early foothold in Asia for possible expansion in the future, either to identify future sources of supply and manufacturing or to develop emerging sales opportunities.

Stuart Burns is Managing Director, Europe and Asia Pacific for Aptium Global Inc. Stuart can be reached at 44.1329.227.424 or by email at sburns@aptiumglobal.com.

Q&A with Jason Busch on Sourcing Technologies

Jason Busch is Managing Director of Azul Partners, a consultancy that works with technology vendors and service providers. He most recently spent 5 years at FreeMarkets, the pioneer in online auctions and strategic sourcing.

Q: If I am a $25m manufacturer, what is the one type of sourcing technology
that I should be using?

A: The one type of technology should be an on-line negotiation tool which includes RFX and reverse auction capability. Even with limited use, this type of application should more than pay for itself within a few months. If you are not working with a service provider who includes this technology as part of their offering, there are a range of vendors who have developed creative pricing models for one-time and periodic use.

Q: Should I buy a hosted or behind the firewall application?
A: There is no reason why any small to medium sized organization should consider installing software for sourcing and procurement initially. Hosted applications are typically much less expensive to get up and running and are cheaper to use and maintain on an on-going basis.

Q: Who are the leading vendors for the following types of applications:
a. Auctions and eRFX, b. Data aggregation/spend analysis, c. Supplier identification

A: For auctions and eRFX – Ariba (FreeMarkets QS), Procuri, Iasta, and Verticalnet (B2eMarkets) have the strongest applications. For data aggregation/spend analysis – Ketera, Ariba, Verticalnet, Zycus and Emptoris are my picks. For supplier identification, I think this is a weaker application set but Thomas Register (domestic and global edition), Alibaba.com and FirstIndex all have solutions. Ariba has service-based solutions acquired from FreeMarkets, but little is embedded in stand alone technology.

Q: Will sourcing functionality be embedded in mid-market ERP applications?
A: Eventually, yes. In their mid-market offerings, SAP has already made some strides to include reverse auction capability, as has Oracle. Peoplesoft is a bit of a joke (try finding a single paying reference), but that won’t matter long, will it, if Larry gets his way … but today in general, even SAP’s and Oracle’s functionality remains limited at best and inexpensive hosted providers offer a more capable solution at a lower price point. In five years, however, I would expect much of this capability to be included in most leading mid-market ERP packages.

Q: Who do you trust for your advice on these technologies?
A: There are a few publications which are worth reading which are good sources of information—Purchasing Magazine, Supply & Demand Chain Executive are two that come to mind. I would also recommend reading Aberdeen’s research as well (www.aberdeen.com) as much of it is very thorough, detailed and inexpensive or free to download. The other source to trust is AMR Research (prior to Pierre Mitchell’s departure) but they charge to read their reports. Forrester Research, Gartner, and Meta occasionally have good things to say but are not worth the investment for smaller organizations, given their current limited coverage of the sector. Most important, I would not go to a Big 4 firm or any technology integrator and ask for advice. Many have preferred partnerships in place and they will steer customers to use these solutions often in exchange for kickbacks and integration dollars.

Jason Busch is Managing Director of Azul Partners. Jason can be reached at 773.525.7406
or by email
jbusch@azulpartners.com.

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.

Aptium Global, Inc.
421 W. Melrose
Floor 10, Suite C
Chicago, IL 60657

Phone: 773 525 9750
Fax: 773 525 7496

 

Aptium Global UK
PO Box 453
Eastleigh
Hampshire SO531WY
UK

Phone: 44 2380 273 671
Fax: 44 1329 227424

Aptium Global India Liason Office
A-7 Nizamuddin East
Defence Colony
New Delhi 10013

Phone: 91 11 51825101
Fax: 91 11 2435 2826