The Nature of Supply Dynamics Part II: Commodity Based Cost Models Alone Aren’t Enough

You’re partof a progressive Supply Management organization that has strategically sourced the top 10 categories by spend, supplier, geography, and department. The low hanging fruit has been picked, the big fish have been fried, and you’ve even implemented a catalog-based tail spend solution to make sure all spend is at least visible, if not managed or minimally sourced. There are no more obvious avenues for big savings, yet the CFO and CEO are still screaming for savings (despite the fact that you should be focussed on working with Sales to identify low-cost value-adds and NPD to take cost out before those unnecessarily fussy and short-sighted engineers bake it in), so what do you do?

You take a hint from your forward thinking peers, start doing cost break-downs on your more expensive categories and products, and look for raw materials with a high-spend that could potentially be reduced by consolidation on behalf of your suppliers. But are the opportunities real?

Just because your organization spends $20 million on steel doesn’t mean it spends $20 million on steel. It might spend $3 million on carbon steel, $2 million on nickel steel, $4 million on nickel chromium steel, $1 million on chromium steel, $5 million on molybdenum steel, $3 million on tungsten steel, and $2 million on silicon-manganese steel. While that’s $20 million on “steel”, it’s not the same “steel”, and might require half a dozen different suppliers in an area to provide at acceptable quantity and quality levels. Not the leverage an initial spend analysis might suggest.

Moreover, even that $4 million of nickel-chromium steel might not be $4 million of nickel-chromium steel. You could easily be buying four primary grades: 1.25% Nickel, 0.8% Chromium (31xx); 1.25% Nickel, 1.07% Chromium (32xx); 3.5% Nickel, 1.5% Chromium (33xx); and 3.0% Nickel, 0.77% Chromium (34xx) in roughy equal quantities, with a few other grades thrown in. This means your “volume” leverage is at most $1 million per grade of steel. Not a huge volume leverage at the end of the day.

A cost model tells you where your money is going, but not necessarily where your opportunities are. You need to drill into the bill of materials for the product, extract the specs, and see where there is enough standardization for negotiation leverage. And then you need to work with engineering to see where greater standardization can occur so that, as new designs come in and old designs phase out, you have more and more negotiation leverage over time.

And that’s why you need good visibility into your product information, which is not something your average sourcing or procurement system captures. It’s the detailed BoM with material composition specs, fabrication requirements, and so on that really allow an analyst to identify the real raw material (or even energy in deregulated markets) volume leverage savings opportunities, not the phantom opportunities that arise when a superficial spend analysis using systems designed for indirect spend are used.

And you need this information on an ongoing basis. Just because you spent $4M this year on nickel-chromium steel doesn’t mean you’ll spend $4M next year on nickel-chromium steel. Maybe most of the buy was in cancelled product lines and the new product lines have all switched to molybdenum steel, which means that could be where the real opportunity lies — if the grades can be standardized and agreed on by the various engineering teams. With regular updates, trends can be projected and predicted, even if sales or engineering forgets to inform Procurement that a product line was suddenly cancelled at re-sourcing time.

In other words, the nature of supply dynamics is that for both real supply assurance and real supply chain savings you need detailed product information that goes beyond a cost model and even a high level bill of materials, and an ability to work with that data.