Category Archives: Cost Reduction

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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The Real Price of Cost Cutting

Last November, Basware released a research report on “Cost of Control: The Real Price of Cost Cutting” that expanded upon their “Cost of Control” research summary (that they released last June) with in-depth interviews to illuminate some of the key issues that will form supply management strategy in the years to come. The white paper illuminated some good points which I’d like to expand on in this post.

Technology is Key to Efficiency

The report noted that respondents are alive and alert to the potential of efficiencies delivered through the use of technology, although IT investment is tight in the current market and that investment funds are likely to be made available where the business case is able to deliver tangible, short-term savings. This is positive — in that business are starting to see the value technology can deliver, and negative — in that business won’t invest unless they are convinced they can see immediate payback. In other words, as long as the market is tight, they are going to postpone new technology purchases and continue to bleed year after year, hoping that they’ll still have blood left when the economy improves.

Unfortunately, this report, like many others, did not address how to deal with this problem. The answer lies not in the ROI analysis (which is there, but not always rapid enough to justify six or seven figures up front) but in the approach to technology acquisition and payment. Businesses need to understand that it’s a tough economy for vendors too and that you don’t need to pay for it all up front anymore. Not only can you start with a SaaS pay-as-you-go solution (which will generate instant savings as long as you select a solution that costs less per month than the minimum average monthly ROI you expect), but most businesses will give you a payment plan in this economy, even if you buy a perpetual license. Furthermore, you can also pay as you go on services and support, and many organizations will even give you a payment plan on up front installation and integration if a lot of work is needed. Vendors would rather be paid tomorrow for work done today than not be paid at all.

Procurement and Finance is a Tense Relationship

A number of recurring issues erode the relationship between the functions but encouragingly cause regret on both sides. Whether Procurement reports to Finance or to the Board, Procurement has to work hand-in-hand with Finance, respect the cash-flow realities of the business, and make purchases that have the greatest positive impact to the bottom line. You’re not saving 2% by agreeing to early payment if you have to borrow the money at 24% annual interest because your customers are all paying late. Cost of capital, currency conversions, cost of commodity risk management (through hedge funds, futures, etc.) all have to be taken into your total cost of ownership equation — not just unit price, shipping price, storage price, and tariffs.

Again, the report presented no clear advice on how to resolve the conflict. While there is no answer that will be right for everyone, you need to start with the formation of cross-functional teams on every sourcing project which includes a Finance representative who can help you understand the financial impacts and ramifications of a proposed sourcing arrangement. Getting Finance’s input before the contract is signed will go a long way towards easing the tension and maintaining the relationship.

Minor Risks are Important Too

Businesses are looking for the ‘Tsunami’ events that take place in the supply chain, but failing to keep track of the ‘soil erosion’ that is more likely to be experienced over time with regards to quality and servicing issues surrounding the supplier relationship. Furthermore, respondents are happy to articulate potential failures among their key suppliers and the discrete disappearance of supplier businesses, but do not appear to pay enough attention to the broader issues created by compound supplier instability.

The fact of that matter is that if a number of minor risks materialize simultaneously, they can be just as devastating as a major risk materializing. Let’s say you make a product that requires five key components. What if all five suppliers experience problems at the same time and your orders are delayed at least 90 days from each supplier, in your peak season. One component, you could probably go into recovery mode and find a replacement quickly. Two components, super-charged fire-fighting mode. Five components? Forget it! All risks and suppliers have to be tracked and attention paid if leading indicators indicate trouble.

In other words, regardless of what fire you’re fighting today, there’s a big picture and you better not lose track of it. But it’s important to have a plan, and that’s where the report stops short.

Finally, don’t forget that, Across-the-Board Year-Over-Year Savings Targets are Stupid. After all, I even gave you Yet Another Reason Across-the-Board Year-Over-Year Savings Targets are Stupid.

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Yet Another Reason Across-the-Board Year-Over-Year Savings Targets are Stupid

This morning I told you how year-over-year savings targets are costing you a small fortune right now. Now I’m going to tell you how they cost you a large fortune over the long term.

Typically what happens in a company that gets serious about cost reduction as a result of a knee-jerk survival reaction in a recession is that, if they can attract one, they bring in a top-notch CPO. This CPO pulls the weeds out of the organization and replaces them with strong trees, acquires some decent tools (or at least access to some on-demand SaaS tools), institutes good processes, and brings in expert consultants to assist on the strategic sourcing of key categories where her team is weak. Over the next couple of years, the team kicks ass and exceeds their savings targets and everyone is happy. The corporation is saving money and the team is getting lots of kudos and bonuses for a job well done.

But then the inevitable happens. The economic cycle runs its course, the next economic boom occurs, demand for raw materials skyrockets, and prices go up, often significantly. As a result, it becomes impossible for the CPO and his team to get any year-over-year savings in any of the high-spend categories, which they had negotiated down to razor-slim margins when the supplier was desperate. (After all, not only is the supplier being offered a lot more money for a limited supply, but the supplier can’t even cover its input costs at last year’s prices.)

Then management, used to price reductions and unwilling to admit, and sometimes unable to even understand, the new market reality, makes another knee-jerk reaction and fires the CPO, with no plan for cost containment — which is much more important than cost savings. A monkey with an auction platform and the ability to use Google and access a D&B report can save you money in a recession when dozens of suppliers are desperate for your business (and will happily forego profits for a chance to survive). But only a true Procurement Pro can contain costs in a boom market when the supplier holds all the cards. A true pro can contain cost increases to only 10% when production costs go up 20%+ through skillful negotiations, collaboration, innovative delivery options, and so on. Everyone else will be lucky to secure supply at a 20% increase, which is what the company will end up having to accept without a procurement master at the wheel. And you’ll end up losing so much money that I don’t even want to attempt to calculate how much it will be, since the profuse bleeding won’t even begin to slow until you get a new CPO at the wheel, who’ll be hesitant to accept knowing that you’re last CPO, who was a superstar, didn’t make the cut.

You see, it’s not how much you save, because there is no such thing as savings. All “savings” means is that you were paying too much in the first place. What matters is the best deal with the greatest total value for every sourcing event, and a performance that outdoes the market average. When you start measuring that way (against competition, indices, and carefully researched should cost models), and calculate year over year improvements appropriately, that’s when you see real performance. Until then, you’re running a marathon you cannot win.

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