There are No Economies of Scale … Just Economic Production Quantities

As the public defender likes to point out on a regular basis over on Spend Matters UK / Europe, economies of scale is a procurement myth. The idea that the more you buy, the bigger discount you can get because the cost diminishes is a myth because, if it were not, if you could buy a large enough quantity, then the cost would eventually get close to 0 per unit.

But the reality is that there are always hard costs that cannot be reduced in the supply chain … particularly those components that involve human labour — product creation, product transportation, product component creation, product component transportation, raw material mining, raw material component transportation, security guards for storage, etc. — and facility leases, utility cost, taxes, etc.

And there are always limits to “economies of scale” production lot sizes. If the line can only do 60 units per hour, then the line can only do 2400 in a normal workweek, 4800 in a double shift work week, 7200 in a triple shift work week and maxes out at 10,080 a week … assuming no downtime (and most lines will require some maintenance). In this case, the major economies of scale are 2400, 4800, and 7200 — as this insures that the labour cost (and facility costs) are spread over the maximum number of units.

In other words, there are economic production quantities (EPQ) where the price per unit is minimized, and this is the optimal economy of scale.

So if you really want to minimize your costs, you can start by minimizing your supplier, and carrier costs, which can be done by appropriately distributing the award across suppliers in economic production quantities that can allow them to give you larger discounts (and still retain a reasonable margin). So how do you do that? Considering that each supplier has a different EPQ, each carrier has a different EPQ, and this varies by product (and plant location), how can you possibly figure out how to split in such a way that you can enable suppliers to reduce their bids?

If you’re a regular reader of Sourcing Innovation, you know the answer. A decision optimization platform …

Why do you need a process for Procurement?

Procurement is the action of procuring …

To procure is to obtain with care …

Just doing a random search on your favourite web store and clicking “buy” on the first product that might fit your needs does not involve the application of care.

That’s why you need a process … and preferably a platform to back it up.

Simple enough explanation?

The More Things Change … Roll On!


Roll on highway, roll on along
Roll on daddy till you get back home
Roll on family, roll on crew
Roll on momma like I asked you to do
And roll on eighteen-wheeler, roll on (roll on)
Alabama

We’re still being promised drone delivery, but the reality is most goods still move over land by truck (even if rail is more environmentally friendly and uses less fuel and could be built to use renewable energy, especially for short haul or common lanes, if we went back to a powered track … ) … and those trucks Roll On!

Ten years ago we noted that, despite the fact you need those trucks to Roll On, your logistics could come to a screeching halt. You could wake up and there could be no one to drive the truck (due to a continuing driver shortage or a unionized strike), no fuel to gas it up (due to shortages caused by a natural disaster, etc.), or, worse yet, no truck at all (because your delivery company can’t afford the new insurance premiums, which is a harsh reality — a few years ago minimum insurance requirements were jacked up across the board and small mom-and-pop shops had to shut down, and it could happen again).

And the situation has’t changed. The sky isn’t falling, but without proper planning, that includes contingency plans, with the continual driver shortage, constantly rising fuel prices (and seemingly regular shortages due to poor planning and resiliency on the part of the providers and an increasing array of governmental regulations in developed countries), and increasing thefts of expensive automobile — and truck — parts (with restricted supply) to take advantage of high (scrap) metal prices, any company could find itself in a situation where the sky might as well be falling.

And the eight pieces of advice given by Lora Cecere (the supply chain shaman), then of AMR and now of Supply Chain Insights, are just as relevant now as then.

  • Plan for tighter capacity
  • Make Fuel Management Part of Risk Management
  • Get the Right Supply Chain Planning (SCP) Master Data
  • Rethink Customer-PickUp (CPU) Programs
  • Diversify Entry Ports
  • Face Reality — (Re)Design Your Network for Efficiency
  • Get Help from a Good Partner
  • Make U.S. Transportation Infrastructure an Item on the National Agenda*

As are the three pieces of advice the doctor gave you ten years ago:

  • Use Decision Optimization
  • Don’t Forget Security
  • Invest in Visibility

And the only thing we’d add is that when you have to spot-buy, spot-buy smartly. Use new services like Freightos. Don’t know who they are? Better find out … NOW! (SI Freightos intro … and they are Flippin’ Freight Quotes Faster than a Fleet-Footed Feline on Guarana … Still!)

*Best of luck getting anything accomplished with your current administration — hard to buy American to build American when there are no more American-made options!

The More Things Change … Negotiations

Ten years ago we posted timeless principles to steer you through negotiations and, looking back, they truly were timeless. Each is as true today as it was then as they were a decade before we summarized them.

Negotiating is not about dividing up a limited pie in ways that are divisive. It is about making a bigger and better pie.

If each side sees the pie as small, then each side is going to want a bigger piece of that pie. But if the pie is large, both sides will be happy with a piece that is about half.

Conflict is at the heart of negotiation but only a positive view of conflict will result in a successful outcome.

Both sides must believe that a resolution will occur that both sides will be happy with.

There is a time to speak and a time to shut up in negotiations. When you do more listening than speaking, you actually increase your power.

If you don’t understand what the other side wants, really, really wants, then how do you know what you really need to give up and what you don’t? After all, you must

Recognize that you will only reach agreement by understanding the deeply-held needs of the other side.

Both sides make a lot of demands, but at the end of the day, only a few of the demands will generally be non-negotiable.

In power negotiations, when the stakes are high, let the other side believe what you or they want them to believe. But don’t lie or be dishonest.

If you can distract them away from what the biggest value is to you, it might help.

You can only succeed in negotiations with a win-win attitude.

As per our first point, you have to be focussed on enlarging the pie so you can divide it up in a way that both sides see a win.

Negotiating is an essentially human way of interacting.

That’s why you will get to keep your job when Procurement bot takes over inventory, re-ordering, spot-buying, and the vast majority of your job.

The More Things Change … Supplier Intelligence

This week we’re revisiting posts from ten years ago to demonstrate that, to date, the more things change in Procurement, the more they have, unfortunately, stayed essentially the same.

Ten years ago we published a post on what you can’t afford not to know about your suppliers that summarized some key insights from Jim Lawton (who was VP of Marketing at Open Ratings until its acquisition by D&B, where he became SVP and General Manager of Supply Management Solutions).

Jim, who noted that global supplier insight can become as indispensable to sourcing and supply management as a stage is to an actor, also noted that in order to acquire this insight, an organization has to focus on:

  • supplier performance and quality management,
  • supply risk management, and
  • supplier content and connectivity

And nothing has changed. Any organization that wants to understand total landed cost from global markets and with predictability still needs these capabilities today. Considering that the the final cost of any purchased product is ultimately dependent on the supplier and its ability to delivery a product to spec on time and on budget with minimal defects, supplier performance management is as critical today as it was a decade ago.

Similarly, considering that a single disruption can wipe out the entire identified and negotiated savings on a category (as the result of a six week disruption), supply risk management still takes center stage. (This goes double when the chance of an organization not experience a disruption is 15% or less for any 12 month period.)

Finally, without an understanding of supplier policies, practices, and the providers your suppliers employ, you’ll never know whether or not they are adhering to your corporate social responsibility standards, whether or not they are implementing six sigma and other best practices to ensure quality and keep defects down, and whether or not they are buying from, or subcontracting component development to, third parties that don’t adhere to your quality, responsibility, or ethical standards.

Supplier Intelligence is as important now as it was then, and, most importantly, many organizations don’t have the depth of intelligence they should have, as evidenced on the relative lack of uptake of modern Supplier Relationship Management solutions.