While I believe that the average company is still chasing the cost reduction myth (as highlighted in eyefortransport’s recent Global Chief Supply Chain Officer Strategy – European Focus report, for example), I am having a very hard time understanding why. As SI has pointed out a number of times over the past couple of years (including in it’s recent piece on the Top Ten Things To Do in 2013 To Control Costs), for any organization that has been pursuing any form of supply management over the past five years or so, cost reduction is a fantasy that’s not going to happen within your tenure. Inflation is back with a vengeance — it will be decades, if ever, before we see a return to the 1% inflation rate we enjoyed in the noughts. Global food reserves are at fifty, and in some cases, one hundred, year lows — and the past couple of years have seen riots in the first world over the cost of basic staples (like wheat and rice). And with rapidly increasing global demand, certain raw materials are scarcer than they’ve ever been. In other words, cost reduction is a pipe dream.
Moreover, recent research by Supply Chain Insights LLC (recently released in Supply Chain Metrics that Matter: Driving Reliability in Margins) has demonstrated that, for the average company, cost reduction never happened anyway. That’s right! You might have saved millions in those auctions when you had the power, or taken millions out of your distribution chain with optimization, but cost increases across the board ate up those savings in other areas. The researchers found that through analysis of publicly available balance sheet and income statement data [from 2000 through 2011], we find that 75% of companies in process industries lost ground on margins and only 5% of companies improved their positions on the number of days of inventory! In other words, despite all their supply management efforts, relatively speaking, their costs went up.
This isn’t to say that you shouldn’t be focussing on supply management or cost control, with rising, and increasingly volatile, raw material and commodity prices, supply unpredictability, demand unpredictability, and the rate of supply chain disruptions increasing super linearly, cost containment is a must. But thinking you’re going to reduce costs in this economic climate is foolish. The best you will do is control them — and that will be the difference, for many companies, between staying in business and filing for bankruptcy. Literally.
What you need to be focussing on is not cost, but cost drivers and how you are going to maintain visibility into those drivers to help you figure out where costs can be best contained, when your organization will likely have the greatest (or least) advantage in a negotiation, and how much cost certainty is worth. For example, is it worth locking in a one year contract when prices are volatile and possibly higher than the projected prices due to a recent disaster that reduced supply? They could go up if demand increases, but if another source of supply appears in six months, or the backlog of orders is cleared, they could return to pre-disruption levels (which will still be higher than last year).
So how do you do this? We’ll discuss it in part two.