Category Archives: Cost Reduction

Know Your Software TCO & TVM

I’m a big fan of SaaS (Software-as-a-Service). I’m a big fan of the many benefits it offers, including almost instant deployment, immediate upgrades, and the fact that the provider handles the administration, maintenance, security, upgrades, backups, and other IT headaches that most companies just don’t have the IT resources for. And I’m a big fan of the economies of scale that are inherent in a true multi-tenant instance. But I am not a big fan of the recent marketing by a number of the vendors in the space that have recently gone “on-demand”. Most of these new “On-Demand/SaaS” providers have taken a myopic focus on TCO in their marketing, and are making strong claims that On-Demand/SaaS is always cheaper – which is not true.

Regardless of the software delivery model you select (on-site, hosted/ASP, on-demand/SaaS), there are a lot of factors to consider with respect to the Total Cost of Ownership and which model is cheaper ultimately depends on the specifics of the vendor pricing and your internal costs of support. A true multi-tenant SaaS provider who takes full advantage of the economies of scale across a large customer base and who passes those savings on to you will often be cheaper, but this is not always the case. Some On-Demand/SaaS providers aren’t as cost efficient as they claim, some solutions require a lot of manual (data) maintenance and user support (which results in hefty service fees), and, let’s face it, some providers, who will do a magnificent job of convincing you that on-site costs more than it actually does, will charge as much as they can get and use the bulk of your monthly subscription fees to line their pocket books with large annual bonuses. If you can’t calculate the true TCO of each solution under considering, you’ll never know which solution is more cost effective and when you’re truly getting a good deal.

I’ve addressed this issue in the past for e-Sourcing and e-Procurement systems in my post on uncovering the true cost of on-premise sourcing & procurement software (spreadsheet), but since many of you will soon be buying / upgrading again now that money has finally started to trickle back into your budgets, I thought I’d address it again. Especially since the calculation isn’t that much more involved for just about any type of Supply Management technology you might be considering. Basically, all you do is compute the (expected) x-2, x-1, x, x+2, and x+2 year amortized solution cost for the length of time, x, that you expect to maintain and use the software (based on typical enterprise solution lifespans in your organization) for each product under consideration, compute the average annual amortized cost, compute the expected savings, and select the solution with the highest ROI that best fits your organization.

Depending on the delivery model, the following will contribute to the total solution cost:

  • License Cost
  • Maintenance Costs
  • (Expected) Upgrade Costs (to Major Versions)
  • Base Hardware & Networking Costs
  • Hardware Upgrade Costs
  • (3rd Party) Data Costs
  • Database / Data Warehouse Costs
  • Application Server Costs
  • Reporting / Analysis / Optimization Engine Costs
  • Other Required Software Costs
  • System Design, Implementation & Integration Costs
  • Security Costs
  • Support Costs
  • (Re-)Training Costs

You calculate the total cost for each time-frame on a cost component basis using expected upgrade schedules, pricing trends, and expected utilization curves. Then you divide the expected total cost of ownership by the time frame and you get your annual amortized cost, or TCO by year.

Then you compute the expected savings by computing the expected cost savings in each of the following primary dimensions:

  • spend reductions (you expect to realizeequal to savings you expect to negotiate minus savings you expect to lose to maverick spend)
  • efficiency / productivity improvements
  • risk mitigations (which prevent losses due to supply disruptions, non-compliance fines, etc.)

Finally, you can compute the (annual amortized) ROI, or the Total Value Management, of each solution as the (annual amortized) expected savings / expect cost. Then you can truly compare each solution under consideration on a cost, and value, basis.

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Global Sourcing: Addressing Myths with Capabilities Part I: Cost & Quality

Today’s post is from David Henshall, Founder of Purchasing Practice. Dave can be reached at dhenshall <at> purchasingpractice <dot> com.

In this four part series, we examine eight dimensional capabilities that will help you overcome the myths surrounding global sourcing. In today’s post, we will focus on the two dimensions of cost and quality.

The myths surrounding global sourcing are many, widespread and often misleading. They usually revolve around business conducted in developing countries, the so called low cost country sourcing (LCCS) countries. LCCS is fertile ground for the politicians, humanitarians and environmentalist alike, covering misleading sound bites ranging from the export of jobs to the exploitation of child labour and the carbon footprint of the 3000 mile salad.

With the prospect of such reputation damaging headlines, it is critical for firms engaging in global sourcing to get their strategy right. This strategy must be supported by sound operational capabilities that not only manage the supply chain and the relationships within it, but that also make use of a well thought out communications strategy (should unwanted publicity arise).

Purchasing Practice has developed a global sourcing framework (GSF) that incorporates these concerns into a logical management structure, and categorises them under eight dimensions.

 

The Eight Dimensions of the GSF

  1. Cost
  2. Quality
  3. Corporate Social Responsibility
  4. Risk
  5. Opportunities
  6. Politics
  7. Local Context
  8. Enabling Infrastructure
Global Sourcing Framework
Click to Enlarge
The Breakdown of Global Savings Costs
Traditional Model

(based on industrial products example)
labor savings 20-25%
depreciation 5-10%
materials and components 10-15%
economic development incentives 0-5%
savings on manufacturing cost (subtotal) 50%
logistics, inventory costs -10-15%
ongoing management costs -5-10%
taxes and duties -0-5%
net cost savings 25%
Procurement Strategy Council Model

(factoring in hidden costs not considered in the traditional model)
cost savings in traditional model 25%
business partner non-participation -8%
business partner non-compliance -6%
savings (subtotal) 11%
resource intensive sourcing activities -4-5%
reputation risk exposure and mitigation -1-2%
actual savings realized 4-6%

 

Dimension #1: Cost

Whilst costs are typically a primary driver of global sourcing, organisations must not only factor in total landed cost but also issues such as infrastructure cost and increased risk. This can include the cost of setting up a local office or hiring external auditors to monitor your suppliers in a particular country. Additionally, an upfront investment is frequently necessary in order to ensure the sourcing relationship is aligned with business goals and policy.

When these factors are quantified in a sourcing decision, the incremental savings from sourcing to a higher risk region or country are sometimes eliminated, especially when the principle benefit is labour arbitrage. However, many organisations are finding that the benefits of global sourcing still outweigh the investments if the right global partner is in place.

According to a Procurement Strategy Council report:

“Traditional models assessing the costs of global sourcing most often consider higher logistics and inventory costs due to longer supply chains, greater management costs to oversee remote and (often) unfamiliar supplier relationships, and higher taxes and duties. While these costs can reduce net savings by roughly half, emerging markets still provide a significant cost advantage of upwards of 25% savings.” See the breakdown of global savings cost table (above).

So whilst there are low cost countries, global sourcing will always be worthy of a buyer’s attention. Buyers should, however, be aware that the state of comparative cost advantage is dynamic, not static. This is true both within and between competing countries. Buyers must therefore possess the skills and motivations to monitor these dynamics as part of their overall sourcing strategy.

Dimension #2: Quality

Quality is usually a given in procurement organisations these days and is not ‘knowingly’ compromised for cost savings. Successful LCCS can deliver quality that is equal to, if not better than, local sources. This is in part achieved by working with suppliers to help them reach the desired quality standard prior to calling off production. When this is the case, it must be recognised as an additional cost of doing business and factored into sourcing decisions over the long term. The key lies in putting in place all the right quality processes and checkpoints throughout the supply chain by qualifying inputs before they become embedded in products.

The increased risk of materials substitutions (i.e. lead paint and low grade materials) can also be driven by the refusal of Western buyers to allow suppliers to pass along cost increases which become amplified during a recession. So buyers must consider this when reviewing prices with suppliers.

Part 2 will examine Corporate Social Responsibility in global sourcing.

Thanks, Dave.

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Supply Chains are More than the Sum of Their Parts

Everyone should read this recent article in Strategy + Business on Virtuous Connections that presents a case study on how local “fixes” that don’t take into account dependencies can actually result in global “breakdowns”. The article, which presented a case study from a large chemical manufacturer, described how numerous attempts to “fix” existing supply chain issues resulted in the creation of additional supply chain issues that were even worse and more costly.

For example, the article describes how:

  • they focussed on pallet standardization, only to find no performance improvement because being able to load a pallet faster doesn’t help much if the products aren’t ready when you need them;
  • they installed a system-wide network that couldn’t handle the volume of incoming orders because management underestimated the range and volume of the company’s channels; and
  • they tried outsourcing warehousing, which made matters worse because their software didn’t integrate with the 3rd party’s software.

But when a more holistic view was taken and Supply Chain focussed on:

  • segmenting customers by strategic importance, which allowed reps to give customers a more realistic picture;
  • eliminating rogue stock-replenishment processes by replacing them with new, standardized processes dictated by a properly selected and calibrated inventory system; and
  • including risk constraints in schedule production that took into account order complexity, which greatly increased schedule predictability,

the results were astonishing. Inventory on hand decreased by 20 percent, shipment costs stabilized in a period of rising fuel prices, and stock-outs fell by 50 percent — resulting in exponential gains.

When they failed to look at the big picture, intended “improvements”, including the selection and integration of expensive new systems, had disastrous consequences because their “side effects” were never taken into account. But when they analyzed the system as a whole, even minor changes had major positive impacts. You need to look at your supply chain as a whole, and select systems that allow you to analyze the supply chain as a whole. Otherwise, that “fix” might introduce a fatal flaw!

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A 2-Minute Opportunity Checklist for Supply Chain Initiatives

Slightly modified, the 2-Minute Isenberg validation test for business ideas, as chronicled in this HBR Blog post on “the 2-minute opportunity checklist for entrepreneurs”, is a great test to determine which supply management initiative you should run with. Specifically, if you line up your opportunities, the one that scores highest is the one most likely to get the organizational support you need for success and the one that you should focus on in your quest for purchasing fire.

It’s 17 short questions, and I would recommend that you answer yes to at least 13 of them before proceeding with any effort that is going to take a lot of time and resources.

  1. Will your initiative ease the pain, frustration, or dissatisfaction of someone outside of Supply Management?
  2. Are there more of these people in the organization?
  3. Will any of these people commit budget or resources to get it done?
  4. Will they be able to make a decision to support your initiative quickly?
  5. Does the initiative exploit and showcase a strength of Supply Management?
  6. Are you able to bring to bear unique assets in the initiative?
  7. Can you think of at least two C-Suite executives who will support you?
  8. Can they commit resources with complementary skill sets?
  9. Will they see the value that you do?
  10. Do you have evidence that you will be able to convince a majority of the decision makers that your idea is a good one?
  11. Will at least one person disagree with you?
  12. Is the idea compelling enough that your staff will do what it takes to get it done?
  13. Can you sneak by the trolls in accounting and get it done?
  14. Can you find someone in the organization who will commit to trying it and help you work out the kinks?
  15. Can you start without a huge cash outlay up front?
  16. Can you keep the long-term costs low?
  17. Does the initiative lay the foundation for future incremental initiatives that will generate more cost reductions and additional value?

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What’s Your Procurement Value Level? … Strategic? (II)

In Part I, I reminded you that Pierre Mitchell of The Hackett Group invited you to participate in a study that would help you identify where you were on your procurement journey by way of 18 value streams that range from “naive apprentice”, where you’re measuring performance at an elementary (tactical) level, to “expert sourcerer”, where you’re extracting procurement value at a very advanced (transformational) level. Considering that this survey will not only help you identify a path to increased value but that Pierre has promised to share some of the results with all survey participants for free, it’s a survey that’s definitely worth your time as Hackett has the premiere benchmarking data in the space.

I also told you that the first seven value streams were tactical and provided relatively little ROI compared to the ROI that is available through more advanced value streams. The next six value streams are strategic and will generally provide you with good payback over a longer term. They range from:

Costs avoided by receiving ‘no charge’ items and services
through
Early payment discounts, P-card rebates, or other supply chain finance benefits
to
Internal enterprise process costs are reduced via a new supplier solution

Costs avoided by receiving ‘no charge’ items and services

Now we’re into strategic procurement where the “savings” are real and sustainable. By negotiating in more items and services for the same money, you’ve considerably reduced your costs and increased the value that you can provide your end customers for the same price. And while it’s true that the ‘no charge’ items and services could disappear at contract termination, you’ve established with your supplier(s) that you expect a higher level of performance and service, which will make future negotiations, and cost-avoidances, easier.

Early payment discounts, P-card rebates, or other supply chain finance benefits

Now you’re starting to look at the total cost of the buy from an organizational perspective, and not just a unit cost or landed cost perspective. If your supplier’s annual cost of capital is 36%, and yours is less than 12%, you could be saving yourself up to 24% annually, or 2% for each month you shave off the total payment time. This can be substantive and is easily sustainable. Plus, once you get good at managing your working capital and finances, you’ll start to see even more savings opportunities appear.

Internal enterprise process costs are reduced via a new supplier solution

Once you get to the point where you start recognizing that sometimes you don’t know all the answers and that a smart supplier can point out additional opportunities for you to save money, you have not only mastered the art of strategic sourcing, but have reached the point where your sourcing is on the verge of becoming transformational … which is the topic of Part III.

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