Category Archives: Cost Reduction

Sometimes Old-School Works Just Fine: An EC Sourcing RFP Case Study

It’s still a buyer’s market. Many suppliers are desperate for business, supply (capability) still exceeds demand in many markets, and even though prices are starting to rise in some markets with expectation of recovery, they haven’t risen much yet. According to many strategic sourcing professionals, it’s the perfect market for an (e-)Auction because suppliers will compete for your business. And while that may true, it does not guarantee that you’ll get the best result.

An e-Auction carries a number of risks. The result can be higher prices than a traditional negotiation. For example, if the auction was limited to a small number of suppliers, who are in contact, they may collude to keep prices high — or they may all adopt a strategy of delayed bids and minimum bid decrements which could result in higher prices. The result could be unsustainably low prices. A supplier, desperate to win business, might hope to make up losses in future volume, bid a razor thin margin, and then risk bankruptcy when its costs rise. At this point, the only choice for the organization would be to accept higher prices (through surcharges) or risk an interruption while a search for a new supplier was conducted. And the result could be strained supply base relations. A poorly conducted event can instill animosity in winners and losers alike, which would result in poor service from the winners and lack of response in future bid requests from the losers.

As a result, sometimes the best approach is an old-fashioned multi-round RFX with feedback between each bid, as it was for a certain mid-size apparel retailer, who we’ll call Apparel-For-You, who was new to e-Sourcing and just wanted a way to streamline their ocean freight bidding efforts (for their 25M ocean freight category) and communicate with suppliers in a consultive way. Specifically, Apparel-For-You, not realizing the significant savings opportunity before them, had the following goals in their search for an e-Sourcing solution:

  1. Understand Supplier Willingness to Bid on a Per Lane BasisHistorically, Apparel-For-You had been surprised a number of times not only with respect to bids that came in, but with respect to lanes carriers were willing to bid on individually
  2. Reduce Analysis and Reporting TimeApparel-For-You’s supply base, which provided them with over 2,200 individual SKUs, was spread across 30 ports of origin, 4 major ports of destination, 9 carriers, and 4 container types — which equals 4,320 bids to be collected and analyzed before the 120 lanes can be divided among the carriers. While certainly not impossible to do by hand, that’s still 10 (9 carrier plus 1 integrated) fairly large spreadsheets to manipulate and analyze in a time consuming and error-prone manner.
  3. Communicate with Suppliers in a Consultative and Regular FashionWithout a dedicated sourcing tool, it’s difficult for all team members to know when a carrier was last contacted and what was discussed. The ball could be dropped, and this could lead to a damaged relationship. Given the importance of relationships in Apparel-For-You’s supply chain, as apparel has a short product life-cycle, this is something Apparel-For-You wanted to avoid.

Given these requirements, and Apparel-For-You’s lack of e-Sourcing sophistication, EC Sourcing recommended that Apparel-For-You use a multi-round RFX, starting with an RFI to find out which carrier was interested in which lanes, with analysis and feedback between each round. The carriers were all informed up-front of the new process, and Apparel-For-You consistently followed-through after each round.

Using the built-in templates, Apparel-For-You was able to easily create an RFI that allowed it to create the right pricing matrix for each supplier as well as clarify important T&C’s with each. The process of collecting bids from carriers, who were used to Excel, was simplified by way of Excel integration. This integration also simplified the amalgamation of the bids into a single matrix for analysis purposes, as the integration was automated and free from human error.

Using built-in reports and advanced analysis models provided by EC Sourcing, Apparel-For-You was able to quickly analyze the bids after each round and provide the supplier with feedback on their relative ranking, which included how much they’d have to lower their bids to improve their rank and take the #1 spot. Using this information, the carriers were able to adjust their bids accordingly and focus on the lanes they could perform the best on with respect to the buyer’s needs.

In the end, Apparel-For-You not only accomplished their goals of

  1. Understanding Supplier Willingness to Bid on a Per Lane Basisas this information was known before the first bid was collected
  2. Reducing Analysis and Reporting Timeas the project time-frame was reduced by 35%
  3. Communicating with Suppliers in a Consultative and Regular Fashionas they were able to inform the carriers of their rank and potential awards promptly after each bid, and track when the last discussion took place

but Apparel-For-You also reduced their costs by 19%.

This just goes to show that, sometimes, old school works just fine. The full case study is available in PDF form.

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Price is Only ONE Component of Cost

A good reminder of this is Jim Anderson’s recent piece on The Total Cost Approach for Dealing with Unmovable Prices over on The Accidental Negotiator. As Jim notes, the purchase price of an item is not really the true price that we’re going to end up paying for it. There are lots of additional costs, fees, and services that go along with it. Ultimately it’s the total cost of what we’re going to end up paying that really counts, not just the initial purchase price. So if the seller won’t move on unit price, focus the negotiations on another cost component.

As Jim notes, if you’re buying fleet vehicles, negotiate on service costs, warranties, financing, etc. Decent (extended) warranties can easily run you over a thousand per vehicle, and if the vehicle is made well, this is all profit for the manufacturer (as the warranty will expire before something major goes wrong). Here’s an easy few hundred (or more) per vehicle with very little effort. Plus, your average vehicle will need (at least) a few thousand dollars of regular services over the first 60K miles / 100K kilometers, most of which is profit at high hourly service rates. If you’re buying in bulk, you can easily save thousands by negotiating a significantly lower hourly rate. And then financing could run you ten thousand or more per vehicle. Knocking a few percentage points off the rate can save you a small fortune.

If you look at the total cost, it’s often easy to negotiate quite a few percentage points away when you move away from the “fixed price” to the variable total cost components, some of which will be high margin (with lots of negotiating room). Especially since the seller will generally want your business and move where she has wiggle room.

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PPV is a Bad Measure of Procurement Performance

As noted in a recent brief from ChainLink Research, PPV (Purchase Price Variance) is a bad metric for Procurement, especially if your buyers’ performance is being based on it. Not only does this kind of metric encourage behaviour that may lower PPV but create a higher total cost, but it can cost your organization a bundle, and this goes for commodities that usually have low volatility as well as those that have high volatility. Here’s why.

Let’s say you were buying 10,000 barrels of crude oil in 2009 on a monthly basis. The OPEC basket price, which started the year at 40.44 on January 2 and ended the year at 77.16 on December 31, and which reached a low of 38.10 on February 18 and a high of 77.88 on December 1, varied, on average, by $7.20 a month, with a minimum variance of $2.91 in November and a maximum variance of $13.30 in May. If your buyers are being measured on PPV, and they are good at predicting annual pricing trends, chances are they are going to pay as close to $65.04 as possible, as this amount (and any amount between $64.00 and $66.08, to be precise) minimizes the average monthly PPV. (The PPV varies from 0 in July and September to $21.14 in February and averages out to $7.46.)

In this situation, your buyer would spend 7.34 Million dollars trying to minimize PPV, which would cost your organization 467,200. This is what your buyer would pay each month (buying on the day that was closest to the price point target):

Month Price Cost PPV
Jan 46.32 463200 14.82
Feb 43.90 439000 17.24
Mar 50.77 507700 10.37
Apr 52.26 522600 8.88
May 63.71 637100 2.57
Jun 66.08 660800 4.94
Jul 65.04 650400 3.90
Aug 68.04 680400 6.90
Sep 65.12 651200 3.98
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 61.14 611367 8.55
SUM   7336400  

But if your buyer was focussed on cost avoidance, your buyer would only spend 6.87 Million dollars trying to minimize cost, saving your organization 467,200. If you ignored PPV, this is what your buyer would pay each month (buying on the day that allowed for the lowest purchase price):

Month Price Cost PPV
Jan 39.29 392900 21.85
Feb 38.10 381000 23.04
Mar 41.79 417900 19.35
Apr 47.15 471500 13.99
May 50.41 504100 10.73
Jun 66.08 660800 4.94
Jul 59.66 596600 1.48
Aug 68.04 680400 6.90
Sep 64.00 640000 2.86
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 57.24 572433 11.18
SUM   6869200  

Still think minimization of PPV is a good idea?

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Marketing is a Huge Savings Opportunity

Sourcing Innovation’s recent Illumination on Strategic Spend Visibility noted that best-in-class companies that strategically source their marketing spend save an average of 14.7% on five marketing and spend categories compared with a mere 7.8% savings for all other enterprises (as per a recent Aberdeen Group study) and that, across the board, with good visibility, an average marketing organization can easily find 20% to 25% savings with Procurement’s help (as per a recent Ariba report).

Why? Last year’s report from the Marketing Supply Chain Institute on why you need to “Define Where to Streamline” makes it clear. A surprising 62.9% of survey respondents admitted they had never undertaken a comprehensive audit and analysis of costs and process efficiencies in their marketing supply chain. Almost two thirds of companies have never analyzed their costs! (And yet they wonder how most of their supplier reps can afford to drive Beamers, Benzs, and Jags!) Furthermore, only 10.8% are adopting workflow or collaboration systems to reduce costs, only 11.5% have a back-end marketing platform to optimize resources and process, and only 14.2% admit that their marketing is fragmented.

In other words, Marketing is a savings gold mine. Turn your strategic spend analysis system loose and the savings opportunities you discover will be numerous indeed.

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Even Good Times Call For Lean Supply Chain Strategies

A recent article over on the Harvard Business Review blogs told us that we should “stand by for the same old strategy mistakes”, because you see the same ones over and over again every time a downturn starts to trend up again. Moreover, similar fundamental strategy mistakes are often made by supply chain organizations when the economy starts to improve. As a result, there are lessons to be learned. Three easy ones are:

  • Too many supply chains.Many companies think they should have multiple supply chains — one for commodity electronics, one for custom parts, one for chemicals, etc. — as this will allow for a razor-sharp focus on streamlining operations around a category. The reality is that you should have only one supply chain (from a planning and management perspective), because every (distinct) supply chain costs money to manage and operate. Just like a business loses when it splits its focus (as 20% of operations will end up accounting for 80% of profit), a supply chain loses when it splits its operations.
  • Throttling back on cost reduction.When times improve and profits start to increase, supply chain often starts to think it can ease up on the push for ever lower prices, give suppliers a break, focus on quality, and / or focus on collaborative initiatives that will take cost out in the future. While it is important to focus on (these) other initiatives, you can never cease your cost reduction quest.
  • Pushing too hard for supplier consolidation.While it is true that most companies have too many suppliers in the supplier master, with 20% of active suppliers accounting for 80% of spend, and while it is true that a smaller supply base can enable greater spend leverage, too much consolidation too fast can greatly disrupt your supply chain.

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