Monthly Archives: November 2016

The Nature of Supply Dynamics Part II: Commodity Based Cost Models Alone Aren’t Enough

You’re partof a progressive Supply Management organization that has strategically sourced the top 10 categories by spend, supplier, geography, and department. The low hanging fruit has been picked, the big fish have been fried, and you’ve even implemented a catalog-based tail spend solution to make sure all spend is at least visible, if not managed or minimally sourced. There are no more obvious avenues for big savings, yet the CFO and CEO are still screaming for savings (despite the fact that you should be focussed on working with Sales to identify low-cost value-adds and NPD to take cost out before those unnecessarily fussy and short-sighted engineers bake it in), so what do you do?

You take a hint from your forward thinking peers, start doing cost break-downs on your more expensive categories and products, and look for raw materials with a high-spend that could potentially be reduced by consolidation on behalf of your suppliers. But are the opportunities real?

Just because your organization spends $20 million on steel doesn’t mean it spends $20 million on steel. It might spend $3 million on carbon steel, $2 million on nickel steel, $4 million on nickel chromium steel, $1 million on chromium steel, $5 million on molybdenum steel, $3 million on tungsten steel, and $2 million on silicon-manganese steel. While that’s $20 million on “steel”, it’s not the same “steel”, and might require half a dozen different suppliers in an area to provide at acceptable quantity and quality levels. Not the leverage an initial spend analysis might suggest.

Moreover, even that $4 million of nickel-chromium steel might not be $4 million of nickel-chromium steel. You could easily be buying four primary grades: 1.25% Nickel, 0.8% Chromium (31xx); 1.25% Nickel, 1.07% Chromium (32xx); 3.5% Nickel, 1.5% Chromium (33xx); and 3.0% Nickel, 0.77% Chromium (34xx) in roughy equal quantities, with a few other grades thrown in. This means your “volume” leverage is at most $1 million per grade of steel. Not a huge volume leverage at the end of the day.

A cost model tells you where your money is going, but not necessarily where your opportunities are. You need to drill into the bill of materials for the product, extract the specs, and see where there is enough standardization for negotiation leverage. And then you need to work with engineering to see where greater standardization can occur so that, as new designs come in and old designs phase out, you have more and more negotiation leverage over time.

And that’s why you need good visibility into your product information, which is not something your average sourcing or procurement system captures. It’s the detailed BoM with material composition specs, fabrication requirements, and so on that really allow an analyst to identify the real raw material (or even energy in deregulated markets) volume leverage savings opportunities, not the phantom opportunities that arise when a superficial spend analysis using systems designed for indirect spend are used.

And you need this information on an ongoing basis. Just because you spent $4M this year on nickel-chromium steel doesn’t mean you’ll spend $4M next year on nickel-chromium steel. Maybe most of the buy was in cancelled product lines and the new product lines have all switched to molybdenum steel, which means that could be where the real opportunity lies — if the grades can be standardized and agreed on by the various engineering teams. With regular updates, trends can be projected and predicted, even if sales or engineering forgets to inform Procurement that a product line was suddenly cancelled at re-sourcing time.

In other words, the nature of supply dynamics is that for both real supply assurance and real supply chain savings you need detailed product information that goes beyond a cost model and even a high level bill of materials, and an ability to work with that data.

The Nature of Supply Dynamics Part I: Unknown When Unmanaged

Despite the constant pressure from the CFO to squeeze every peso out of the supply chain (not penny, that’s not good enough any more, they want to squeeze tenths of a penny now), the primary purpose of Sourcing is not cost reduction — it’s assurance of supply. (And that’s why Sourcing Innovation prefers Supply Management terminology over Procurement and Purchasing, but that’s another post.)

Assurance of supply is no easy feat. Just because you do a sourcing event, identify a supplier, cut a contract, send a purchase order, and arrange a delivery date, it doesn’t mean the product is going to show up. The product might not be manufactured on time due to a a raw material shipment delay on behalf of a tier 2 supplier or a production line breakdown. The shipment might be lost, stolen, or under 3 km of water. Or, the supplier might go bankrupt. Either way, no supply.

But this is a risk that can be fairly well managed through proper supplier qualification, production tracking, shipment tracking, and dual-supply. However, a bigger risk, and one that keeps the CFO (vs. the COO) up at night is the cost control measures you put in place during negotiations to keep supply affordable so the company (knowing that there is always a ceiling to what customers will pay) can maintain profitability.

If you are in an advanced Supply Management organization, one measure you are probably taking is aggregating raw material supply needs across products and categories and buying the raw materials on behalf of the supply base as your volume can often net a better deal than individual suppliers that supply products purchased in lower volume or that use lesser amounts of expensive raw materials (like steel and rare earth metals). This measure can save an organization a lot of money in markets where prices can fluctuate 50% or more in a few months, but only if the suppliers buy off of the contracts you tell them to when they are supposed to.

But how do you insure this? And more importantly, how do you even know what they are doing? Your organization can put in the contract that they have to buy off of any raw material contracts your organization mandates and your organization can ask them to report regularly, but how does your organization really know? The account rep might report 95% compliance and claim only a few “off-contract” purchases due to the need to buy emergency supply as a result of a late shipment, but the reality could be the exact opposite. And you can ask for records, but will you get the right ones?

If you don’t have anyway of keeping tabs on the situation, and managing it to whatever extent it can be managed, it’s completely unknown. It’s the nature of supply dynamics, and why visibility is needed both into, and across the supply chain. So how do you get it? More on that later in a later post. But first, how do you know the analytics is right and the master contracts are appropriate in the first place?

Always Remember That While the Second Mouse Gets the Cheese …

… the third mouse gets nothing — unless you count the opportunity to bury the first mouse in a shallow grave before he dies of starvation something.

As Pete Loughlin reminds us in his recent post, “when conventional wisdom goes wrong”, most enterprises make one of two mistakes when selecting enterprise technology. Either they go with the same-old, same-old incumbent technology (that never solved their problem in the first place), or they go with a bleeding edge start-up (because their eagerness to please can be exploited). For the vast majority of companies, neither solves the problem.

While many startups will have something new and innovative, most don’t have the breadth or depth required to support a large organization — even if that is their ultimate target market. Start-ups are good for (smaller) mid-size organizations that need a point solution, or large organizations that just need one thing done better — they are not good as platforms. Similarly, if your ERP has failed you for 10 years, starting yet another customization project with a big 8 consultancy that has yet to deliver what they promised on any project isn’t a good idea either.

The best solution for many organizations is typically a new vendor with a newer, or more appropriate, solution, but not one that is so new that it has not yet been around long enough to be adequately stress tested and proven to have the breadth and depth required for the organizational size and need. A (smaller) mid-size organization should already be using it successfully and it should be clear that the solution has enough scale-power.

It’s often a hard call, but that’s why impartial expert technology consultants — who do not (re)sell solutions* — should be engaged. In particular, they should be engaged to help an organization identify the processes it needs to support, the key functionality that a platform needs to offer (but not features, as sometimes multiple feature sets can solve the same problem), the scale the platform will need to support, the data that will be required, the integrations to other enterprise systems or external data sources to fetch this data, and the breadth of deployment that will be required to support the processes. Then, they should help the organization construct a proper RFP (that describes the current process, the problems, the desired process, and ultimate goals) and identify potential vendors to send the RFP too, as well as demo requirements, scoring and weighting systems, and best practices in vendor selection. But they should not sell, or have any interest in, any of the solutions — they are guides through the dangerous enterprise jungle, not treasure map peddlers.

And, most importantly, as Pete points out, if the expert is engaged, she should be listened to. Otherwise, the organization is not only wasting money on the executive’s gut-feel technology platform, but also on the advice that was going to be ignored anyway. Always remember, there’s no gold in them thar hills, but there is in the advice of a wise sage.

just a reminder that the doctor does not have any interest in, or receive any compensation for, any technology that he may or may not recommend, unlike many analyst firms that charge per lead and per sale