Daily Archives: February 7, 2012

Can Cost Management On Its Own Be Strategic?

A recent issue of eSide Supply Management published a piece on Strategic Cost Management and the Supply Base that, while full of good advice, might be misleading to an up-and-coming Supply Management practitioner who needs to be set on the right road early on. However, before I can explain, let’s review the key points from the article.

The article started off great when the author noted that:

      It might sound obvious, but when faced with a cost improvement challenge from your business, a good place to start is to think about what you’re practically being asked to do. Does the scope of the request apply to an innovative product or service whereby you more likely need to achieve an optimized cost, while simultaneously trading off against other attributes such as performance, delivery channel or customer appeal? Or, is the focus on a current product or service which is no longer deemed competitive or requires maintenance of a current selling price via cost reduction efforts.

The reality is that cost management is not simply keeping prices down. It’s keeping total cost down — where total cost is the total lifecycle cost of the product, which includes acquisition, manufacturing, distribution, sale, warranty, return, and disposal — while keeping total value up — which includes quantitative factors such as low defect rates and high reliability and qualitative factors such as market appeal and differentiation. And the best way to achieve this goal will be different for every product.

And the goal will always be cost, and not price, reduction, because cost reduction is typically sustainable over the long term, while price reduction is often a short-term commercial concession, which is then typically reversed later when the power balance in the buyer/supplier dynamic changes.

However, cost reduction is a more difficult task, especially when the suppliers have power, but there are tools available to help the buyer. The author does a good job of pointing out some of them, including:

  • analytics and benchmarking
    which can provide a buyer with a detailed cost breakdown and a foundation for an accurate cost (of production and distribution) model — which helps the buyer understand how much it should be costing the supplier and what level of profit margin the supplier is trying to get
  • integrated product teams
    whose collective understanding of the product or service from a production, distribution, use, and repair and recovery perspective can shed insight on potential opportunities for cost reduction that a supply manager may not see on his own
  • supplier involvement (from a technical perspective)
    a good supplier is full of innovative ideas to provide your organization with more value (and keep you as a customer) — especially if you bypass sales and go straight to the product engineers or service professionals (as they know where the cost is)

But even though this will help with the multifaceted, complex and often perplexing arena of supplier cost management that supply management professionals have to deal with on a daily basis, it kind of misses the full picture — that cost is only one component of strategic supply management and if supply is strategically managed, cost will fall in line as the buyer will know what costs need to be managed and what costs (of little consequence) can, more-or-less, be ignored.

After all, it’s usually not the initial price that constitutes most of the cost, but the unexpected expedited deliveries, the unexpected high rate of failure and warranty returns, the cost of unhappy customer retention, the losses associated with inventory stock-outs because the supplier couldn’t deliver on time at all (even with expedited deliveries) that constitute most of the unnecessary cost in a category. Control the supply, control the cost.