Category Archives: Cost Reduction

Are You Going to Be Able to Control Costs this Year?

Costs are rising across categories and verticals and will likely continue to do so. There are a number of direct and indirect reasons for these increased costs, but the most substantial are the following reasons which could collectively rip a supply chain out from under even the largest of multi-national corporations.


1) Inflation is back with a vengeance

Commodity costs are rising across the board. According to the Royal Bank of Canada, the commodity price index increased for the third straight month and hit a five-month high in September. They increased 8.2% since June! Barley and Corn have exceeded the highs of 2008. The price of Live Cattle is almost 50% more than it was just two years ago. Copper is climbing back to its recent high. And these are just a few examples.


2) Market growth is stagnant and, as a result, so is job growth.

Stagnant growth in their markets can limit a company’s ability to increase the breadth of its strategic sourcing activities and get more spend under management, a critical key to cost control. While stagnant markets should be the bugle call for a company to get more spend under management, the lack of resources, primarily due to lack of hiring of new talent and investment in new technology, has kept many companies from expanding the growth of their sourcing efforts. In addition, stagnant market growth means that volume is not going to increase, and this limits a Supply Manager’s ability to negotiate (additional) volume-based savings going forward.


3) There is a widening gap between risk identification and mitigation.

The amount of research on risk and risk mitigation has reached an all time high, but there has been little or no movement towards the identification and implementation of an effective risk identification and mitigation strategy. In 2008, a Marsh survey found that only 35% of organizations self-reported that supply chain risk management was moderately effective at their companies. Stated another way, 65% of companies did not have a risk management program that was at least moderately effective. In 2011, researchers at Vlerick Leuven Gent Management School and Ghent University did a supply chain risk management study and again found that 64% of
the companies have no one responsible for managing supply chain risks! That’s essentially zero improvement in the last
three years!

And these are just three of the reasons (or fates) costs are rising across categories and verticals! For the other four reasons, the seven elements missing from an average Supply Managemnt organization exposing it to these seven fates, and the ten competencies that every Supply Management organization needs to master in order to acquire the seven elements that will allow a Supply Management organization to fend off the seven fates, remember to download the Top Ten Things to Do in 2013 to Control Costs, a free white-paper from BravoSolution (registration required) authored by Sourcing Innovation.

So You Need To Save On Ocean Freight

You could start with these pointers from Inbound Logistics on Reducing Ocean Freight Costs:

  • Consolidate LTL/LCL to FTL/FCL
       (and use 40-foot and high-cube containers)
    It costs almost as much money to run a truck almost empty as it does to run a truck almost full (when you consider that an empty trailer weights around 12,000 lbs or 5500 kgs), so a trucking company has to charge you more on a weight/volume basis if you don’t ship FTL as they might not be able to consolidate someone else’s cargo and lose money otherwise. Similarly, it’s cheaper to ship full containers, and for a carrier to standardized on 40-foot containers.
  • Transload operations to inland destinations
    Once shipments arrive, route them through a transload facility to be repacked and loaded to inland destinations. Avoiding unnecessary warehousing reduces costs and expedites shipments.
  • Make round-trip opportunities available.
    Providing inbound and outbound flows from a location allows carriers to make optimal use of equipment. While it will not be possible from final destinations, especially if shipping direct to stores with transload operations, you can give the carrier outbound shipments from US production facilities / (return) service depots on its return route to minimize it’s costs, and yours.
  • Know the market
    You should know the current market prices for fuel costs, capacity on your lanes, and provider overheads. You should also know total demand. This way you can negotiate a good (fair) deal.
  • Pay carriers on time according to agreed terms.
    Delaying payments only costs your company in the long run. If you don’t, the carriers will likely have to borrow at an interest rate that (far) exceeds any interest you may make keeping the cash in the bank. This means that they will have to build these costs into their fees, which will go up and cost your organization ore over the long run.

Or, you could just eliminate the need for (a significant quantity of) ocean freight (entirely). Let’s face it — 100% savings is WAY more than the 5% to 10% the above will shave off your costs.

How do you do this? Nearsource (or, better yet, Home-source)! In North America, consider Mexico or Brazil. With overseas labour costs and logistics costs climbing significantly year-over-year, for some products, it’s just as economical to produce them south of the equator — especially when you consider overseas labour rates and logistics costs are NOT going down. Now, SI knows this isn’t necessarily possible for all categories (as high-tech requires very advanced production facilities which can’t be thrown up or staffed overnight, for example), but with the exception of high-tech, biotech, and other industries that require a large pool of very specifically educated people and very high-tech production facilities, there’s no good reason NOT to be looking at locales like Mexico and Brazil right now. (And even if the raw materials need to come from overseas, the cost of shipping (refined) raw materials, which are very dense, is much less than shipping final goods, which typically aren’t dense and which require a fair amount of packaging — and which often have lower import duties!)

The Essence of Good Working Capital Management

In yesterday’s post we noted that playing games with working capital only costs the organization in the end; specifically, for every 10% of working capital an organization messes with, it loses 1% of total working capital (or 10% of the working capital messed with). Not a good deal, any way one wants to look at it.

Working Capital doesn’t have to be hard to manage. While an expert can get quite sophisticated about it, all one really has to do is:

  1. Get a good grip on receivables
    What is the organization expecting from sales and when; what reimbursements is the organization entitled to and when; what tax rebates is the organization expecting and when.
  2. Get a clear picture on fixed payables
    What is the average monthly payroll, the average monthly overhead (rent, utilities, etc), and regular non-monthly expenses that are projected over the next year.
  3. Get a good estimate of average disruption costs
    When a receivables disruption has occurred — regardless of if it was due to a late payment, lost customer, lost sales from a competitive product, or market delay due to a supply chain disruption — how much has it cost on average and how long has it persisted. This is the contingency fund that is required (and can be amortized monthly over the next twelve months).

Once this is known, the organization knows how much cash it has to work with every month. Only then can it truly begin working capital management and determine when it should pay early to take advantage of an early payment discount, borrow to pay on time to prevent costs from rising (as the supplier’s cost of capital is much higher than the organization’s), pay late and pay the penalty (as the organization’s cost of capital is higher and/or the supplier is able to bear the burden of payment late more than the organization is able to bear the burden of paying on time), or get innovative and work with the supplier to reduce costs across the supply chain. Without a solid understanding of cash flow, working capital management can’t even begin. And good working capital management definitely doesn’t involve booking revenue early, paying suppliers late, or other quarter and year end games to present a rosier picture than reality, because these games always get discovered and the organization always loses, in hard dollars, in the end.

An Informative Piece on Making Better Decisions with Cost Modelling

The ISM recently published an informative piece on how to “make better decisions with cost modelling”. Given that projected cost modelling can help supply management organizations reduce procurement costs and generate information that could improve cost performance throughout the supply chain, proper cost modelling is something every organization should have a good grip on.

The breakdown graphic is very good. The cost of any particular good is:

  1. the direct material costs plus
  2. the direct labour costs plus
  3. the indirect overhead costs plus
  4. the (amortized) SG&A costs (of the organization) plus
  5. the (amortized) R&D costs plus
  6. the profit margin

The last three costs in particular should not be overlooked. While they will typically be small in comparison to the other costs, they are there, and they cannot be driven to zero no matter what the volume requirements or the economies of scale. They will always exist, and squeezing a supplier’s profit margin to unreasonable levels seriously jeopardizes the health of the supplier. In addition, while tempting to do so, SG&A costs that are not directly applicable to the good being produced should not be included in the indirect cost. While the indirect costs can be reduced with production line efficiency, SG&A cannot.

And cost models are not hard to build, at least approximately. Direct material costs can be estimated using public indexes, direct labour costs can be estimated using government statistics bureau data, overhead costs can be estimated using government statistics bureau data and industry averages, SG&A can be estimated using public filings, R&D cost ca n be estimated as an industry average percentage, and profit margin can be estimated using a fair percentage.

Furthermore, cost models are even easier to correct. Simply state that, unless the supplier proves the model wrong, you will assume that it is right and base your negotiations off of it.

And once you have a correct cost model, you not only gain deep insight into a supplier’s costs, but into their inefficiencies. For example, you will learn where they are spending too much on raw materials, whether or not they are not competitive in labour costs, and where their processes are inefficient. Then, you can work with them to either help them negotiate better contracts with their raw material suppliers or buy on their behalf (with a larger aggregated demand that you can use to leverage a better contract) and to remove inefficiencies from their processes. This can create win-win situations and give you preferred customer status, which will be beneficial if demand outstrips supply.

Your Free* Holiday Gift from BravoSolution

Those of you who are BravoSolution customers should have already recieved Sourcing Innovation’s latest white-paper on the Top Ten Things to Do in 2013 to Control Costs in your inbox, and those of you who aren’t can download it from BravoSolution’s site (registration is required).

If you were following @sourcingdoctor on that which calls itself Twitter on Saturday (Dec 15, 2012), you would have received a sneak peak into two things that will tank your Supply Management Organization in 2013 if you’re not ready, which were culled from this paper, and those of you who weren’t can still follow @sourcingdoctor and read the post (tweeted in 140 character increments) in his tweet history. (Be sure to use Twitter or another twitter feed reader that presents tweets in reverse chronological order or you will be reading the post backwards.)

For those of you who disdain that which calls itself Twitter, this is why you want to download this paper:

  1. It cleary identifies and explains the seven fates that are going to tank your Supply Management organization in 2013.
  2. It points out the seven elements missing from your Supply Management organization that are exposing your orgnization to the seven fates.
  3. It lays out the ten competencies that you have to master in order to acquire the seven elements that will allow you to fend off the seven fates.
  4. It’s what you need – now. And it’s cool.**


* Registration required.

** Actually, it’s awesome, but making it too obvious wouldn’t be modest.