Category Archives: Cost Reduction

Finally, Someone Else Who Gets A Key Point of Working Capital Management!

Regular readers will know that SI has been ranting about all the hype-talk about Working Capital Management for years, including this post where the doctor got sick of all this working capital management talk. The simple fact of the matter is that most companies don’t understand what working capital management really is and mistake screwing suppliers (whether or not it is intentional) for lowering supply chain costs. The reality is that lowering your cost today is not good working capital management if it only raises your cost of acquisition tomorrow.

That’s why it was great to see this recent post over on Purchasing Insight on “Supply Chain Leakage – Stemming the Flow of Costs”. As per the article, when you calculate the scale of costs that leak from the supply chain, it reveals astonishing waste and it’s time that businesses — suppliers and their customers — took a closer look at collaborative techniques to take out these pointless costs.

As the article says, payment terms can be a double-edged sword. While it’s good to contribute to the reduced cost of working capital by extending payment terms, this doesn’t always support healthy supplier relationships and it can put an inordinate strain on the finances of the supplier, which is in the interests of neither party. If your cost of capital is 1%, and your supplier’s cost of capital is 10% or 20%, you’re just increasing your costs by 10% to 20% by paying late to save a paltry 1% or 2% cost on a short-term loan. The numbers just don’t add up.

True savings propagate through the supply chain. They are not limited to your organization.

Good Tips on Strategic Cost Management from the eSide

That’s right. “The eSide”. Not necessarily where you would expect them if you’re old school and always flipping to the b-Side, but that’s the beauty of high-tech. Even though the goal of Supply Management should be to increase value to the organization, the reality is that the C-suite in most organizations, big or small, global or local are still focussed on maintaining — or, preferably, reducing — the costs for procured goods and services. Plus, quick wins in these categories give the organization more leverage to take-on bigger, value-focussed, projects.

However, as the article notes, before you start, it’s worth noting that there’s a discernible difference between price reduction and cost reduction. 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. And, most importantly, managing cost with suppliers who can often considerably help with cost savings is complex and requires a lot of effort.

However, costs are controlled by drivers, and suppliers often have a better understanding of these drivers than your organization does, especially since your organization is typically buying components from these suppliers that are buying raw materials that are the primary components of your cost. And even if the supplier provides a cost breakdown that underpins the price structure, it can be very difficult to understand what the information is telling you. You need a cost model that allows you to provide repeatable analytic capability that lets you understand what the information is telling you and whether costs are going up or down or staying flat. And, as you know, this will require working with knowledgeable colleagues in other functions such as finance and engineering, and the best candidates for the latter will often be in your supplier’s organization. Plus, suppliers will often bring new and innovative ways of reducing cost to the table that might not have been considered previously. Especially if you explore looser specifications with suppliers to broaden the opportunity for cost reduction through innovation and generation of alternative solutions. Remembering that for manufactured products in particular, the majority of suppliers’ costs are incurred at their factories, the suppliers will often have the best ideas for cost reduction — which might come in the form of an alternative (easier to manufacture) design, different raw materials, or even a different manufacturing process.

Suppliers are your allies, not your enemies, and collaborative efforts, focussed on profit sharing, can be the best way to control cost for the long term.

Is Co-opetition a Good Thing for Your Supply Chain?

Not too long ago, the ISM ran a cover story on “Collaborating with the Competition”. In this article, they addressed horizontal collaboration, which is the sharing of supply chain assets for mutual benefits, and which is becoming common among some manufacturing groups. This typically occurs between companies in the same industry that, while not direct competitors, market and sell to similar customers and consumers. As an example, if one manufacturer made HDTVs and another made Blu Ray players, which do require similar raw materials and even chipsets for encoding and decoding, they could cooperate in sourcing because, while they are selling to the same consumer, they are not selling the same product. However, this is now occurring between companies that, at least in some product categories, often directly compete with each other. The case of Hershey Co. and the Ferraro Group, as pointed out in the article, is one example. “Higher-end” hershey bars and “lower-end” Ferraro chocolates are in the same price category and target the exact same consumer that will likely only buy one of these products during a trip to the store. This is an example of co-opetition in the supply chain.

According to the “North American Horizontal Collaboration in the Supply Chain Report”, published by EyeForTransport, while still in its early stages, the benefits [of horizontal collaboration] are clearly recognized and there are companies already optimizing their supply chains with this cutting-edge strategy. This is especially true if the collaboration is deep, and extends into sharing warehousing, distribution and even manufacturing capabilities. And of course, the collaboration is going to achieve efficiencies and savings beyond what either company can achieve on its own if you collaboratively optimize everything, as the article recommends. [This echos what the doctor has been saying for years. No other technology or process delivers the returns that optimization delivers, and the maximum effectiveness is always in a collaborative application.] But the real question is, what is the value that is going to be delivered? When you optimize everything within your organization, you maximize the value to your bottom line. But this isn’t necessarily the case when you optimize a joint supply chain.

Why? To understand the rationale, we need to take a step back to the predecessor of horizontal collaboration — the Group Purchasing Organization. The idea behind the group purchasing organization was that if a bunch of companies came together and pooled their total purchasing volume, they could get a better deal from a single supplier than each could on their own. (In simple terms, they are the enterprise version of today’s consumer GroupOn or TeamBuy.) This was true for each company if they all had volume requirements in the same order of magnitude and there was enough companies in the group to take the volume to the next order of magnitude (which, in manufacturing terms, is defined based on the throughput of a production run and the threshold at which manufacturing the product becomes cheaper). If one company had an order of magnitude more demand than the others in the GPO, then the reality is that it could get just as good of a deal if it had a good negotiator, and if a company had an order of magnitude less demand, then it was getting a way better deal than everyone else.

In addition, a deal is only a better deal if it doesn’t help a competitor more than it helps you. So if the GPO contained direct competitors, typically it was only used for buying indirect or non-essential products or services (like office suppliers, maintenance parts, and temporary labour services), and never for components or raw materials used in direct manufacturing. So the organization never saw the full value of what a GPO could deliver unless it joined a smaller GPO that prohibited direct competitors from belonging to the GPO. And then it still didn’t get the best possible deals across the board because smaller GPOs generally had smaller volumes, especially since not all companies were buying the same products or services, or they were not all ready to buy the same categories at the same time.

Co-opetition is taking the concept of a GPO to the next level. It’s essentially saying “why stop at products and basic services when you can also collaborate on warehousing, transportation, and manufacturing asset purchases and take GPOs to the next level”. And while this sounds good in theory, the reality is that you can really only collaborate this deeply with an organization in the same space as you making similar products, and maximum benefit (from an optimization viewpoint) will only be achieved when they are making the same category of products. And if the other companies are making the same categories of products, even if they are not directly competing (like tablets and laptops), they are probably close enough that they are vying for the same consumer dollars (as many consumers have limited disposable income these days), and if the products are that close, and your competitor ends up getting more efficiency gains then you, with the indirect knowledge of your products that they are going to acquire, what’s to stop them from creating a product that directly competes with yours, at a lower production price, using the supply chain you helped them build?

And yes, there are always legal precautions you can take, but first of all, you have to think of every eventuality and then, if the competitor is determined, be prepared for a lengthy, and costly, court case. In other words, the greater the savings are for you, the greater the value your competitor is likely to see. Is it worth it? the doctor doesn’t have the answer, but thinks it is very important that you ask the question!

How Much Does That Enterprise Supply Management Solution Really Cost, Part II?

In yesterday’s post, we asked how much an enterprise supply management solution really costs because the up-front license cost or annual subscription fee is only one part of the puzzle — and until the full puzzle is understood, it’s hard to figure out what the true cost is and, ultimately, what’s the right solution for the organization. The difficulty is the plethora of license models, and add-on fees, that have been invented by on-premise and SaaS/Cloud vendors over the years in an effort to get a leg-up on their competition (and a siphon into your corporate piggy bank). In today’s post, we’re going to review three proposals from three vendors, Siphon, Skimmer, and Drip. Then, we’re going to demonstrate how to compare them on equal footing.

Siphon is proposing an on-site enterprise solution with a perpetual license cost of 50K plus 100 per user, an implementation fee of 20K, an up front customization fee of 15K for reporting, 25% maintenance, and up-front training of 10K for administrators and 20K for users. It also requires a database, application server, and a middleware license — which have their own maintenance fees. It also requires (3) servers to host the product, space in the data centre, an administrator / developer to maintain the customizations, and a user support person.

Skimmer is proposing a hosted ASP solution with a perpetual license cost of 50K, an additional fee of 50 per user, an additional fee of 1K per integration, and a small transaction fee of $1 per transaction. Maintenance is 10%, but the initial implementation cost is 40K, not counting the 20K for custom reporting or 20K for integration with external systems. User training is 20K up-front.

Drip wants to go pure multi-tenant SaaS for a hosting fee of 40K a year, with 30K up front for implementation, 20K up front for custom reporting, 10K for external systems integration, and 20K up front for training. However, ongoing training, largely self-led, is minimal at 5K / year.

On the surface, Drip sounds expensive if you’re looking to make a 5-year commitment because it’s 200K in license fees, as opposed to 50K for Siphon and 50K for Skimmer, but Skimmer has over 100K in additional up front costs (bringing your down-payment to 150K) and Siphon has at least 75K of up front implementation costs (bringing the total to 125K) plus whatever it costs for the database, app server, and middleware.

The only way to really understand what the respective costs are is to build a detailed cost model that allows for an apples to oranges to pears comparison that allows for similar elements to be compared on an equal footing when possible, and total cost to be understood.

To this end, you need to build a cost matrix similar to the one below (which is contained in this free cost model spreadsheet [that you can use at your own risk*]) so that you can determine the true cost of the solution over the time-span you expect to use it. (Be it the 1, 3, 5, 7, and 10 year time-frames pre-calculated, or some other time-frame). Then fill in the gaps.

For starters, with respect to Siphon’s proposal, we have to cost out the database, application server, and middleware. When we do that, we find that the db license is 15K plus 30% annual maintenance, the application server is 10K plus 25% maintenance, and the middleware server is 20K plus 20% maintenance. Plus, we need to buy 3 servers to support it — one for the application and middleware, one for the database, and one for the web application server. Digging deeper, we find out that it needs five custom module integrations, and each will cost 2K, tacking another 10K onto the proposal in addition to the 10K required to integrate with external systems. Digging into the support requirements, it’s going to require 50% of an admin’s time, and that person costs 90K a year, and 100% of a support rep’s time, and that person costs 60K a year. The servers will consume about 6K of power, an additional 3K of backup services will be required, and the annual maintenance on the database, middleware, and app server will cost 5K, in addition to 5K of annual training to keep the admin up to date.

Skimmer, being a hosted ASP solution, also requires an annual hosting fee of 20K for data centre costs in addition to the 50K perpetual license cost, and an additional fee of 10K in each subsequent year for training.

Drip, being a pure multi-tenant SaaS, has no other costs.

When we put it all together, we end up with the table below:

Cost
Components		 On-Premisee Hosted ASPP SaaS
Perpetual License (K)
Flat Fee 50 50 0
Per User 0.1 0
# Users 100 0
Per Module 0 0
# Modules 5 0
Per Integration 2 0
# Integrations 5 0
Per Server 0 0
# Servers 3 0
Total 70 50 0
Annual Hosting Fee (K)
Base Fee 0 20 40
Per User 0 0.05
# Users 0 100
Per Module 0 0
# Modules 0 5
Per Integration 0 1
# Integrations 0 5
Per CPU Hours 0 0
# CPUs 0 0
Per Transaction 0 0.001
# Transactions 0 300
Total 0 30.3 40
Maintenance % (0-1) 0.25 0.1 0
Equipment Up Front
Server Count 3 0 0
Server Cost (K) 8 0 0
Server Life-Span (Yrs) 3 0 0
Total 24 0 0
Mandatory Software
Perpetual DB License (K) 15 0 0
DB Maintenance % 0.3 0 0
Perpetual App Srvr License (K) 10 0 0
App Srvr Maintenance % 0.25 0 0
Perpetual Middleware License (K) 20 0 0
Middleware Srvr Maintenance % 0.2 0 0
Total Software (K) 45 0 0
Total Maintenance (K) 11 0 0
Implementation Cost (K) 20 40 30
Ext. Sys. Integration (K) 10 20 10
Custom Report Development (K) 15 20 20
Upfront User Training (K) 20 20 20
Ongoing Training (Yearly) (K) 10 10 5
Data Center Costs
Admins/Developers Rqrd 0.5 0 0
Annual Salary (K) 90 0 0
Support Reps 1 0 0
Annual Salary (K) 60 0 0
Power (K) 6 0 0
Integrated Systems Maintenance (K) 5 0 0
Backup Fees (K) 3 0 0
Ongoing IT Support Training (K) 5 0 0
Total 124 0 0

And then when we summarize the costs, breaking them down into first year and subsequent year, we get the following summaries:

Up-Front
First Year Costs		 On-Premise Hosted ASP SaaS
Perpetual License 70 50 0
Equipment (Computer) 24 0 0
Mandatory Software 45 0 0
Base Implementation 20 40 30
Ext. Sys. Integration(s) 10 20 10
Custom Reporting 15 20 20
User Training 20 20 20
Year 1 Data Centre 124 0 0
Year 1 Hosting/Subscription 0 30.3 30
Total Up-Front 328 180 110
Ongoing Yearly Operating Costs On-Premise Hosted ASP SaaS
Hosting/Subscription 0 30.3 40
Maintenance Fees 17.5 5 0
Mandatory
Maintenance Fees		 11 0 0
Equipment Upgrades 8 0 0
On-going Training 10 10 5
Data Centre Costs 124 0 0
Total Yearly 170.5 45.3 45

And then we quickly see that, in the first year, SaaS is the cheapest and On-Premise the most expensive and, more importantly, that going forward, On-Premise is considerably more expensive due to high data centre costs. We also see that, overall, SaaS will be the cheapest solution but this doesn’t mean it is the right solution as the cost of Hosted ASP and SaaS in subsequent years is almost the same, and if the Hosted ASP provider can offer substantially greater security and reliability with the single instance they are offering (as opposed to the multi-tenant SaaS solution), it might be worth the additional 70K up-front cost for the Hosted ASP solution — especially if the company is looking to commit for a longer term (like 5 years). Plus, With the costs so similar, a negotiation might be able to reduce the base implementation and integration costs, putting the Hosted ASP solution on par with the SaaS solution. However, none of this would be clear without this total cost calculation. So do your homework, and your detailed year-over-year costing, before selecting a solution. It will pay off.

* All warranties or representations, express or implied, are disclaimed and you take complete responsibility for the use, or misuse, of the template.

How Much Does That Enterprise Supply Management Solution Really Cost, Part I?

Pardon my language, but GFQ: Good Fracking Question! With the way that most providers price these days, it’s really hard to tell and bravo! to Chain Link Research (CLR) for taking up the issue in a recent 2-part piece on SaaS Pricing: Insanity or Good Deal for Users (Part One and Part Two). When I first broached the subject back in 2009 in my series on An Enterprise Software Buying Guide (Part I: Overview, Part II: Cross Functional Team Formation, Part III: Need Identification, Part IV: Potential Solution Identification, Part V: Cost Model Definition, Part VI: Cost Model Calculations, Part VII: Negotiations and Part VII: Contract Definition & Management), I thought I was the lone crazy voice talking to the cat in the corner that wouldn’t listen because, at the time, everyone thought SaaS was always cheaper and the wave of the future. (Sometimes it is, sometimes it isn’t.) The reality is that up-front license cost or annual subscription fee is only one part of the puzzle, and until the full puzzle is understood, it’s hard to figure out what the true cost is and, ultimately, what’s the right solution for the organization.

As the CLR articles point out, the first thing you have to figure out is what you’re buying. Is it on-premise, hosted ASP, or SaaS/Cloud, and then, more importantly with respect to today’s cost models, is it enterprise or community? I.E. Is it 100% internal to your organization or does it allow you to connect with different organizations within the extended enterprise as well as supply chain partners? Is the price fixed, per usage metric, or based on Spend Under Management (SUM)? If your organization only has 20% SUM today but is buying the solution to get to 80% spend under management, then the cost of the solution is going to quadruple overtime. What sort of user connectivity is supported? Is it in-house only? Remote? Multi-location? And, today, multi-device? (Executives want everything, whether it makes sense or not, to work on their iPad and/or iPhone.) How secure is it? And how much hardware and/or how many data centre resources are going to be required to support it?

If it’s on-premise/hosted ASP, is the license perpetual or for a limited term? If it’s SaaS, is it single-tenant or multi-tenant? What sort of availability or security assurances are there? Is anything being outsourced?

And then, once you get a grip on the basic delivery model, you need to start coming to terms on how the solution is being priced. For SaaS, what is the frequency of subscription payments? What is the payment based on — site license, number of seats, number of transactions, CPU utilization, bandwidth utilization, storage requirements, and/or dollar volume processed? And what are the up-front costs? Is there a one time integration or implementation fee? Any customization fees? Any training fees? The list goes on.

Similarly for enterprise. Is the license fee fixed-term or perpetual? Site license, by user, by server, or by CPU? Does it require any middleware that must be licensed separately? What is included in the way of implementation and integration? In terms of user training and, more importantly, site administrator / developer training? How much customization is required? The list goes on.

For an average business user trying to select the best solution for the business, it’s like trying to compare apples to oranges (which can be compared, by the way — see this post) to processed fuel (which is of an entirely different composition and has an entirely different production cost model, unless, of course, it’s corn-based ethanol). But there is hope! Stay tuned for Part II!