Category Archives: Cost Reduction

Key Success Factors for Commodity Risk Management

Accenture’s recent white paper on “taking control in the new era or price volatility” listed the following as the four most important success factors for managing commodity risk. At a high level, they’re spot on.

    • Procurement & Finance Alignment
      A risk policy needs to underlie all activities in both departments to insure the risk appetite of the buyer matches the risk appetite of the corporation. The mitigation strategies have to be implemented appropriately. These means that some risks cannot be ignored while others have to be carried.
    • Expertise in Managing Commodity Supply & Price Developments
      When do you buy, how long do you contract for, and how much inventory do you carry?
    • Visibility into Demand Throughout the Supply Chain
      This is the only way to truly measure the impact of raw material fluctuations on the business.
    • Effective Performance Measures

Specifically, measures which link the actual purchase price of a commodity to its market price which allow true savings to be calculated as a percentage savings against expected price and the impact of raw material price fluctuations to be assessed.

Unfortunately, the paper was sparse on implementation details, but here are some tips to get you started:

  • Aligning Procurement & Finance
    The key here is for procurement to lean the language of finance. You can start with Bob’s books on Straight to the Bottom Line and Beat the Odds and Dick’s book on Global Supply Management and Global Supply Chaining.
  • Managing Commodity Supply & Price Developments
    The key here is to stay on top of trends and understand what they mean. Your supply management blogs like Sourcing Innovation, Supply Excellence, and @ Risk will help you out here on a regular basis.
  • Demand Visibility
    Technology will really help out here. Get a good supply chain visibility platform with good forecasting capabilities and you’ll get a handle on how much you need and how long you should be buying for.
  • Performance Measurement
    As the white paper noted, year-over-year savings is not a good measurement. What if raw material prices dropped 20% and you only saved 10% — then you left 10% on the table. That’s not good at all. Similarly, if raw material prices went up 20% above the board and you kept cost increases to 10%, that’s a big, big win. Year-over-Year doesn’t capture that. You should be measuring year-over-year savings as the % change in cost over indexed raw material prices. The calculation is a bit more involved than a simple year-over-year differential, but a much more accurate view into how your supply management organization is truly performing. An example calculation is below given the following raw material costs:

    Raw Material Index Price per Unit Units per Commodity Cost per Commodity
    X $10.01 0.47 $4.70
    Y $7.57 0.34 $2.57
    Z $6.66 1.21 $8.06
    TOTAL $15.33

    If you paid $19.64 per unit, then you paid 128% of indexed raw material cost per unit. If, when you did the calculation last year, you paid 135% of raw material cost, then your year-over-year savings is 7% over indexed raw material cost, which is a 25% improvement (7/28).

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The Role of Optimization in Strategic Sourcing – Optimization Results, Spend Applicability and Business Cases

This series discusses the recent report from CAPS Research on “the role of optimization in strategic sourcing”. The primary goal is to highlight, clarify, and, in some cases, correct parts of the report that are important, confusing, or incorrect to insure that you have the best introduction to strategic sourcing decision optimization that one can have.

This chapter overviewed some of the results obtained by numerous companies as a result of optimization and provided a number of cases studies, including a few that included non-cost elements. A few of the examples are worthy of note. They include:

  • the company who used optimization for cost avoidance in an inflationary market and achieved an ROI of 28%
  • the company that saved 120 Million on a 3 Billion spend, a savings of 4%
  • the company that saved 600 Million

The latter two cases are significant as they demonstrate that returns of up to 100 ROI (in extreme case) are possible since a number of providers now offer unlimited usage licenses for (well) under 1 Million a year. Now, professional services could run up the costs by a factor of 10, but it should still be clear that the ROI claims of 20X to 40X that some providers have stated they have achieved (on certain events for certain clients) are possible.

The cases that were described in detail are very illuminating and the following are worth noting:

  • A National Freight Sourcing Event
    A company decided to rebid 2,200 freight lanes, in an event which was opened up to 65 bidders. The company, which expected a 3% to 6% price increase if they stayed with incumbent suppliers, realized a 5% price decrease, a cost avoidance of 8% to 11%.
  • A Film Packaging Event
    The company required over 2,000 different film packaging items across 70 “families” in an event that was opened up to 45 suppliers. The company was able to involve more suppliers while breaking the price down into 25 cost coefficients per material family, demonstrating the power optimization can bring.
  • Product Containers
    Containers for product across 100 locations were needed. A savings of 8 Million was realized.
  • Ocean Freight
    The company utilized 600 ocean shipping lanes and 3 container sizes per lane. Before the event began, the suppliers projected 10% to 15% cost increases. In the end, price increases were only 1%, a 9% to 14% cost avoidance.

Next Part VII: Optimization and Reverse Auctions

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The Right Way to Cost Cut

I enjoyed this recent McKinsey Article that noted that companies should start any cost-cutting initiative by thinking through whether they could restructure the business to take advantage of current and projected marketplace trends (for instance, by exiting relatively low-profit or low-growth businesses) or to mitigate threats, such as consolidating competitors. This is much better than the usual practice of cutting equally about everywhere because quick head count reductions often come at a price: missing the opportunities that crises can create to improve business systems or to strengthen parts of an organization selectively.

Also, in some cases, efforts to complete merger integration or to use the new economic situation as a spur to renegotiate supplier or other long-term contracts can yield substantial economies. In the authors’ experience, savings of up to 20 to 35 percent in selling, general, and administrative costs are possible with such measures if companies select the right tactics to support their strategies. The reality is that intelligent cost cutting need not reduce the overall scale of the savings that organizations can achieve. By shifting the focus from organizational structure to current and future strategic needs, it makes for smarter savings, even at companies that have already started down another path.

So don’t be another dumb company. If you have to cut, cut smart.

The Role of Optimization in Strategic Sourcing – The Benefits of Optimization

This series discusses the recent report from CAPS Research on “the role of optimization in strategic sourcing”. The primary goal is to highlight, clarify, and, in some cases, correct parts of the report that are important, confusing, or incorrect to insure that you have the best introduction to strategic sourcing decision optimization that one can have.

The second chapter did a great job of highlighting the many benefits of optimization from a productivity, cost/price, and decision visibility perspective. In brief, they are:

Productivity

  • Faster Sourcing Cycles
    No more fiddling with error-prone spreadsheets. (Remember that 90% of spreadsheets contain errors!)
  • More Thorough Analysis
    A broader, deeper analysis that looks at more alternatives.
  • Higher Quality
    Data integrity is much higher.
  • Better Planning
    Better up-front planning is done before the event.

Cost/Price

  • Significant Savings
    Especially on the first event in a category.
  • Cost/Value Trade-offs
    You can analyze whether the additional cost associated with a service is worth it.
  • New Savings Opportunity
    The expressiveness allows suppliers to get creative and find ways of providing you their lowest total cost.
  • True Market Baselines
    An unconstrained scenario will give you the absolute lowest cost.

Decision Visibility

  • Centralized Knowledge-Base
    Your sourcing team can learn from each other and management gets better visibility into cost trade-offs.
  • Cost Premiums
    You can run historical events through the model and determine the cost premiums paid for preferred awards.
  • Cost Drivers
    You can analyze multiple events and zero in on cost drivers such as particular locations or raw commodity categories.
  • Competitive Feedback
    You can let your suppliers know where they are, and aren’t competitive, and why they won or lost a bid.

It also did a good job pointing out that good strategic sourcing decision optimization models also allow qualitative criteria to be analyzed. For example, you can exclude all suppliers with a service level of less than 95% or a product quality less than 8 (on a scale of 1 to 10). The ability to consider non-price decision criteria, used creatively, allows you to model and calculate a wide range of cost vs. value trade-offs and make better overall sourcing decisions. A great example of the power is the user who ran two scenarios where one scenario forced all rubber-based parts against a baseline that allowed the user to gain insight into how the cost of rubber was impacting her costs.

Next Part III: Preparing for Optimization

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Intel Reduces Atom Supply Chain Costs By 70%, But Is It Enough?

A recent article in Supply Chain Digest noted that Intel needed to reduce supply chain costs for its Atom chips by 80% to stay competitive and that, so far, it’s managed to shave costs by 70%. For most companies, this type of cost reduction would be unthinkable. But is it really?

Let’s think about supply chain costs and the opportunity for bloat. We have inventory. We have distribution. We have packaging. We have duties and (value added) taxes. We have inputs. We have production. Etc. Any one of these costs can be extremely bloated. You might think you need nine weeks of inventory when you only need three — there’s 66% bloat. You might think you need air freight when better planning could allow for ocean freight. There’s 50%+ bloat. You might think you need a certain type of packaging when a redesign could be just as sturdy with half the material. There’s another 50% bloat. You might think a tax is unavoidable, but a slight change could eliminate the tax. For example, under some free trade treaties, shipping the printer cartridge separate, instead of pre-loaded, eliminates a VAT. You might think that you need expensive raw material X, when a slight redesign would allow you to produce a better quality product with cheap raw material Y. A slight, lean, re-design of your manufacturing layout might double throughput. Etc. It is a possibility, especially if you have a lot of levers.

However, Intel only had one. Cost-service tradeoffs were off the table, as the chip had to work. Computer chips have about the highest value-to-weight ratios that you can get, which leaves little or no room to improve distribution costs. Intel’s packaging has been getting smaller and smaller over the years, so little room was left in packaging. Once a chip is designed, the raw material needs are locked in (and it still takes years to bring a fundamentally new chip design to market). Due to the nature of chip fabrication, once the plant is built, the process can’t be (significantly) changed. A chip is a single well-defined component, so there’s no wiggle room where duties are concerned. All that was left for Intel was the inventory lever.

For it’s traditional chips, which sold for $100 or more, as compared to the $20 or less selling point for the new Atom chip (which was being designed for the low-cost mobile device market), Intel operated on a nine-week total order cycle time. During the first seven weeks there were typically a large number of order changes — over 90% of orders were changed after initial placement. This led to significant inventory builds as factories spent considerable time optimizing and re-optimizing the factory schedule. However, if Intel could move to a true “make-to-order” model, reduce cycle time to two weeks, plan within four days and allow no changes after that time, the small hit in factory utilization that might would result would be swamped by the reduction in inventory, storage, and handling for all the chips what were currently routed to the DC.

Even though the internal perception was that you can’t truly build to order in the chip industry, an Intel factory was chosen in Asia as the pilot plant and an iterative approach that incrementally ratcheted down from nine to (a little over) two weeks was implemented. The end result was that supply chain costs were brought down from about $5.50 per chip to about $1.40 and that the minor hit that was expected to factory utilization did not materialize.

But is it enough? While Atom chips may be selling for close to $20 now, the market will very quickly force the cost down to about $10 (or less) per chip as more chip makers focus their sights on the mobile markets. Intel expects to get its supply chain costs down to under $1.00 per chip in 2010, but if disruption causes chip prices to fall rapidly, that could still be in excess of 10% per chip! And while supply chain costs of 10% would be welcome in some industries, it’s rather high in the chip industry where they have been traditionally been around the 5% mark, or less.

While I think supply chain will be Intel’s saviour, I think their work is just beginning and that they will have to pull off multiple revolutions to keep Intel at the forefront. Especially since Intel’s legal bill is going to skyrocket yet again as it just agreed to pay $1.25 Billion to settle disputes with AMD and has just been accused of bribing computer makers. This is on top of the $1.45 Billion the E.U. fined Intel in May.

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