Category Archives: Cost Reduction

From the Brink to Cash in the Bank – Supply Chain Management Can Save You Too

The SCMR is back, Quinn is still in charge, and it looks like he’s striving to maintain the quality that the SCMR was known for. I was quite impressed with one of the first articles on driving a turnaround in tumultouos times, which presented a case study on PolyOne and how it came back from the brink of bankruptcy. In March of 2009, it’s share price reached an abysmal low of $1.32. On May 27, it was $10.19. That’s an eightfold improvement in a little over a year and the reason analysts are now recommending it as a buy.

In the past year, it generated $218 Million of free cash flow and reduced its net debt by $233 Million. This is very significant given that it’s sales in 2009 were only 2.061 Billion as it means that PolyOne not only freed up 10% of their total sales for working capital but also managed to direct over 10% of their total sales to reduce their net debt. Plus, not only is their long term debt only 60% of what it was in 2005, but they went from a net loss of 273 Million in 2008 (when sales were 33% higher) to a net income of 68 Million in 2009, an incredible turnaround.

So how did they do this? Great supply chain management. Specifically:

  • Manufacturing RealignmentA series of mergers and acquisitions left PolyOne with over 40 global production facilities, considerably more than it needed to meet demand and mitigate risk. A detailed network analysis indicated that they could more than meet demand and mitigate risk with only 80% of manufacturing capability. This allowed them to close nine production facilities and significantly decrease operating costs.
  • Inventory ReductionAt the end of the third quarter in 2008, the company was carrying $331 Million in inventory, a number equal to 16% of sales in 2009 and an incredible cost. They undertook a two-day Kaizen event to identify opportunities to reduce inventory and cash-to-cash cycle times that identified consignment inventory reductions, opportunities to reduce costs by way of distributors, better inventory transfer practices with key suppliers, and opportunities to improve reorder points. Specifically the first thing they did was kill the re-order points that were on autopilot in the SAP MRP, which didn’t reflect the plummet in demand that came with the economic downturn. Moving to regular, manual review, helped them reduce inventory by $139 Million in just six months.
  • Process ImprovementsThrough numerous process improvements that included inventory stratification, PolyOne also reduced DSI, which dropped from 55 days in first quarter to 37 days in third quarter, while improving on-time delivery.
  • Greater Customer FocusManagement established the mindset that on-time delivery was critical and by improving customer focus, PolyOne improved on-time delivery from 81% in 2005 to 93% in 2009, a 15% improvement.

In short, it was supply chain that saved the day, and its the best practices described in this blog that will get you there. Get a strategy, manage your finances, lean your supply chain, improve your forecasts, optimize your inventory, analyze your opportunities, adopt e-Sourcing, and optimize your awards and you too can go from a net loss of 10% to a net income of 3% literally overnight, on your way to becoming a best in class supply chain company.

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How Will Your Organization Deal with the Sustainability Megatrend?

In a recent post we explained how “sustainability is the current megatrend”, but we did not give you any tips on how to deal with this information. In this post we’ll overview some of the advice provided in a recent Harvard Business Review article on “the sustainability imperative” and address how the sustainability imperative may impact your supply chain.

The first piece of advice given in the article is to learn from past megatrends. For example, in both the IT and quality business megatrends, the market leaders evolved through four principal stages of value creation:

  1. Cost, Risk, and Waste ReductionInitially, companies focussed on reducing costs, and on risks that could drive costs up and waste that also unnecessarily increased costs.
  2. Performance Optimization of Product, Process, or Business FunctionsIn this stage, businesses moved from doing old things in new ways to doing new things in new ways. Processes were transformed using new tools and methodologies so that overall operations were more efficient and more cost effective.
  3. Integration of Innovative Approaches into Core StrategiesInnovation was no longer relegated to a black-ops skunkworks unit as entire business strategies were built around continuous product innovation.
  4. Value Proposition Differentiation through New Business ModelsInnovation was extended throughout the enterprise and transformed the underlying business models.

So what do these classic stages of value creation mean to your organization, and, ultimately, your supply chain?

  1. Cost, Risk, and Waste ReductionIn this stage, a company will focus on outperforming competitors on regulatory compliance and environmental risk management. The company will implement trade manage solutions to keep abreast of current and upcoming regulations, switch to greener raw materials when a choice is available, and switch to suppliers with a lower carbon footprint.
  2. Performance Optimization of Product, Process, or Business FunctionsIn this stage, a company will optimize natural resource efficiency across the value chain. Products will be redesigned to remove environmentally harmful materials and reduce the environmental impact of the production process. Lean, Six Sigma, and related approaches will be applied where appropriate to minimize waste.
  3. Integration of Innovative Approaches into Core StrategiesIn this stage, sustainable innovations become the source of new revenue and growth. For example, the organization will switch from manual paper processes to automated systems to improve efficiency, move to the utilization and creation of energy efficient products, and embrace frugal innovation to capture an increasing share of emerging markets.
  4. Value Proposition Differentiation through New Business ModelsIn this stage, a company will embrace a new business model to the point where it permeates the corporate brand and employee engagement. For example, a car manufacturer may switch its entire product line to hybrids.

And that is how your organization will begin to deal with the sustainability megatrend.

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Sometimes Old-School Works Just Fine: An EC Sourcing RFP Case Study

It’s still a buyer’s market. Many suppliers are desperate for business, supply (capability) still exceeds demand in many markets, and even though prices are starting to rise in some markets with expectation of recovery, they haven’t risen much yet. According to many strategic sourcing professionals, it’s the perfect market for an (e-)Auction because suppliers will compete for your business. And while that may true, it does not guarantee that you’ll get the best result.

An e-Auction carries a number of risks. The result can be higher prices than a traditional negotiation. For example, if the auction was limited to a small number of suppliers, who are in contact, they may collude to keep prices high — or they may all adopt a strategy of delayed bids and minimum bid decrements which could result in higher prices. The result could be unsustainably low prices. A supplier, desperate to win business, might hope to make up losses in future volume, bid a razor thin margin, and then risk bankruptcy when its costs rise. At this point, the only choice for the organization would be to accept higher prices (through surcharges) or risk an interruption while a search for a new supplier was conducted. And the result could be strained supply base relations. A poorly conducted event can instill animosity in winners and losers alike, which would result in poor service from the winners and lack of response in future bid requests from the losers.

As a result, sometimes the best approach is an old-fashioned multi-round RFX with feedback between each bid, as it was for a certain mid-size apparel retailer, who we’ll call Apparel-For-You, who was new to e-Sourcing and just wanted a way to streamline their ocean freight bidding efforts (for their 25M ocean freight category) and communicate with suppliers in a consultive way. Specifically, Apparel-For-You, not realizing the significant savings opportunity before them, had the following goals in their search for an e-Sourcing solution:

  1. Understand Supplier Willingness to Bid on a Per Lane BasisHistorically, Apparel-For-You had been surprised a number of times not only with respect to bids that came in, but with respect to lanes carriers were willing to bid on individually
  2. Reduce Analysis and Reporting TimeApparel-For-You’s supply base, which provided them with over 2,200 individual SKUs, was spread across 30 ports of origin, 4 major ports of destination, 9 carriers, and 4 container types — which equals 4,320 bids to be collected and analyzed before the 120 lanes can be divided among the carriers. While certainly not impossible to do by hand, that’s still 10 (9 carrier plus 1 integrated) fairly large spreadsheets to manipulate and analyze in a time consuming and error-prone manner.
  3. Communicate with Suppliers in a Consultative and Regular FashionWithout a dedicated sourcing tool, it’s difficult for all team members to know when a carrier was last contacted and what was discussed. The ball could be dropped, and this could lead to a damaged relationship. Given the importance of relationships in Apparel-For-You’s supply chain, as apparel has a short product life-cycle, this is something Apparel-For-You wanted to avoid.

Given these requirements, and Apparel-For-You’s lack of e-Sourcing sophistication, EC Sourcing recommended that Apparel-For-You use a multi-round RFX, starting with an RFI to find out which carrier was interested in which lanes, with analysis and feedback between each round. The carriers were all informed up-front of the new process, and Apparel-For-You consistently followed-through after each round.

Using the built-in templates, Apparel-For-You was able to easily create an RFI that allowed it to create the right pricing matrix for each supplier as well as clarify important T&C’s with each. The process of collecting bids from carriers, who were used to Excel, was simplified by way of Excel integration. This integration also simplified the amalgamation of the bids into a single matrix for analysis purposes, as the integration was automated and free from human error.

Using built-in reports and advanced analysis models provided by EC Sourcing, Apparel-For-You was able to quickly analyze the bids after each round and provide the supplier with feedback on their relative ranking, which included how much they’d have to lower their bids to improve their rank and take the #1 spot. Using this information, the carriers were able to adjust their bids accordingly and focus on the lanes they could perform the best on with respect to the buyer’s needs.

In the end, Apparel-For-You not only accomplished their goals of

  1. Understanding Supplier Willingness to Bid on a Per Lane Basisas this information was known before the first bid was collected
  2. Reducing Analysis and Reporting Timeas the project time-frame was reduced by 35%
  3. Communicating with Suppliers in a Consultative and Regular Fashionas they were able to inform the carriers of their rank and potential awards promptly after each bid, and track when the last discussion took place

but Apparel-For-You also reduced their costs by 19%.

This just goes to show that, sometimes, old school works just fine. The full case study is available in PDF form.

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Price is Only ONE Component of Cost

A good reminder of this is Jim Anderson’s recent piece on The Total Cost Approach for Dealing with Unmovable Prices over on The Accidental Negotiator. As Jim notes, the purchase price of an item is not really the true price that we’re going to end up paying for it. There are lots of additional costs, fees, and services that go along with it. Ultimately it’s the total cost of what we’re going to end up paying that really counts, not just the initial purchase price. So if the seller won’t move on unit price, focus the negotiations on another cost component.

As Jim notes, if you’re buying fleet vehicles, negotiate on service costs, warranties, financing, etc. Decent (extended) warranties can easily run you over a thousand per vehicle, and if the vehicle is made well, this is all profit for the manufacturer (as the warranty will expire before something major goes wrong). Here’s an easy few hundred (or more) per vehicle with very little effort. Plus, your average vehicle will need (at least) a few thousand dollars of regular services over the first 60K miles / 100K kilometers, most of which is profit at high hourly service rates. If you’re buying in bulk, you can easily save thousands by negotiating a significantly lower hourly rate. And then financing could run you ten thousand or more per vehicle. Knocking a few percentage points off the rate can save you a small fortune.

If you look at the total cost, it’s often easy to negotiate quite a few percentage points away when you move away from the “fixed price” to the variable total cost components, some of which will be high margin (with lots of negotiating room). Especially since the seller will generally want your business and move where she has wiggle room.

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PPV is a Bad Measure of Procurement Performance

As noted in a recent brief from ChainLink Research, PPV (Purchase Price Variance) is a bad metric for Procurement, especially if your buyers’ performance is being based on it. Not only does this kind of metric encourage behaviour that may lower PPV but create a higher total cost, but it can cost your organization a bundle, and this goes for commodities that usually have low volatility as well as those that have high volatility. Here’s why.

Let’s say you were buying 10,000 barrels of crude oil in 2009 on a monthly basis. The OPEC basket price, which started the year at 40.44 on January 2 and ended the year at 77.16 on December 31, and which reached a low of 38.10 on February 18 and a high of 77.88 on December 1, varied, on average, by $7.20 a month, with a minimum variance of $2.91 in November and a maximum variance of $13.30 in May. If your buyers are being measured on PPV, and they are good at predicting annual pricing trends, chances are they are going to pay as close to $65.04 as possible, as this amount (and any amount between $64.00 and $66.08, to be precise) minimizes the average monthly PPV. (The PPV varies from 0 in July and September to $21.14 in February and averages out to $7.46.)

In this situation, your buyer would spend 7.34 Million dollars trying to minimize PPV, which would cost your organization 467,200. This is what your buyer would pay each month (buying on the day that was closest to the price point target):

Month Price Cost PPV
Jan 46.32 463200 14.82
Feb 43.90 439000 17.24
Mar 50.77 507700 10.37
Apr 52.26 522600 8.88
May 63.71 637100 2.57
Jun 66.08 660800 4.94
Jul 65.04 650400 3.90
Aug 68.04 680400 6.90
Sep 65.12 651200 3.98
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 61.14 611367 8.55
SUM   7336400  

But if your buyer was focussed on cost avoidance, your buyer would only spend 6.87 Million dollars trying to minimize cost, saving your organization 467,200. If you ignored PPV, this is what your buyer would pay each month (buying on the day that allowed for the lowest purchase price):

Month Price Cost PPV
Jan 39.29 392900 21.85
Feb 38.10 381000 23.04
Mar 41.79 417900 19.35
Apr 47.15 471500 13.99
May 50.41 504100 10.73
Jun 66.08 660800 4.94
Jul 59.66 596600 1.48
Aug 68.04 680400 6.90
Sep 64.00 640000 2.86
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 57.24 572433 11.18
SUM   6869200  

Still think minimization of PPV is a good idea?

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