Category Archives: Decision Optimization

The Role of Optimization in Strategic Sourcing – Challenges / Issues

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 addresses the challenges associated with optimization from a user perspective, which, unfortunately, are numerous. The good news is that they are all easily overcome if you are aware of the issues and address them early on.

User challenges fall into three categories:

  • Increased Knowledge Requirement
    • some people will be afraid of the unknown
      easily addressed with a little education
    • others think optimization is a threat to their job
      easily addressed by explaining optimization is not intelligent, users still need to formulate the models
    • many do not understand the power associated with optimization
      easily addressed by a well-defined pilot
    • utilization can require a significant cultural change
      easily addressed by helping an organization define a change management plan
    • there is a learning curve
      easily addressed through repeated use over time
    • the proper constraints need to be utilized for maximum results
      easily addressed with provider support
  • Measurement of Results
    • it can be difficult to tie cost/benefit to the tool
      but a baseline scenario always provides a good measure
    • market timing can affect the event
      but what-if scenarios can illustrate how much more could be saved/lost with price changes
    • good historical data may not be available
      which means you form a baseline by comparing the unconstrained scenario to the cost of a human-generated solution
    • overuse can lead to “analysis paralysis”
      which means you define the relevant scenarios before you start using the tool, and stop when you have analyzed all of the relevant ones
  • Software Provider Issues
    • tools are still evolving
      the provider needs to explain how current functionality will not be affected, only additional capabilities will be added
    • it’s hard for a novice buyer to select the right solution(s)
      a good provider could recommend that the buying organization engage an external, unbiased, expert for educational purposes before evaluating vendor solutions
    • internationalization — are the right languages supported
      this is tough since no tools allow users to add new languages, but there’s no reason a buying organization could not work with a solution provider to create a new translation if it was needed
    • installed vs. on-demand; supplier-driven vs. buyer driven
      this requires a good understanding of your needs
    • some providers recommend minimum event sizes
      well, this is their problem … if they don’t want your business, what can you do?
    • the provider might not understand the buyer’s business
      the provider simply has to spend some time getting to know the customer

Other points to note are the following statements which are somewhat misleading:

  • the first time you save a lot of money, then returns diminish
    while it is true that the first application on a category will see more substantial returns than subsequent applications, creativity can be used to repeatedly find savings that you might not expect through product substitutions, supplier-defined bundles, and alternative delivery requirements
  • demand collaboration, sales forecasts, and performance management … may be perceived as conflicting with optimization
    while some providers who have these solutions and do not have optimization may position these as “alternatives”, they are not the same thing and they do not conflict with optimization — in fact, they enhance optimization because better forecasts and improved performance give you more reliable data which gives you more reliable models which give you better results

Finally, the chapter summarizes some of the suppliers’ perception of adoption barriers which are worth noting.

  • organizational issues
    • leadership conviction is required for a sale
    • a long term focus is required
    • it’s a hard sell to any organization not already using other e-sourcing tools
    • organizations using other e-tools, including auctions, advanced forecasting, and performance management often see optimization as unnecessary
  • inertia
    • too many organizations are content with costs that are “good enough”
    • others “fear the unknown”
    • optimization is not a well understood term in sourcing
    • there is the fear that optimization can eliminate jobs
  • implementation issues
    • significant resources are often spent on supporting today’s customers, leaving few resources for developing better solutions
    • users rarely have clean data
    • the buyers are not always sophisticated enough to properly structure the problem

In other words, your success is in your hands — you have to see the value, acquire a solution, and get trained if you really want to see optimal results.

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The Role of Optimization in Strategic Sourcing – Optimization and Reverse Auctions

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.

In this chapter, the benefits of using optimization with reverse auctions are discussed and a number of case studies are presented. Specifically:

  • Fasteners #1
    Before the event, which was conducted as a reverse auction followed by an optimization-based analysis, the suppliers were projecting a 20%+ price increase. After the two-stage event, the end result was an increase of 11%, which was split among one new supplier and two incumbents, while two incumbents lost business.
  • Fasteners #2
    A company decided to centralize its buy across eight business units. A reverse auction followed by optimization-based analysis identified savings of over $80,000.
  • Shelving
    A shelving buy for 35 stores covering 150 items from 10 different sources realized a total savings of 10% when optimization was applied after a reverse auction.

Next, the chapter discussed the challenge of tiered and bundled bids. They are challenging in a number of respects — they are a challenge to define, they can be a challenge to explain, they are often a challenge to “normalize”, and they can be a big challenge to implement for even sophisticated developers — but not as challenging as the report would have you believe. After all, a few providers support both of these bid-types, and at least two do so in their self-service tools.

The statement that only after the model is solved can it be discovered if the business allocated to a supplier would have been sufficient to earn a discount is false! While the specific solution being used, by the company in the example, may not have supported discounts, a number of solutions on the market fully support tiered and volume discounts, which include the type described within the example. These solutions support models which dynamically update the total cost when a threshold is reached. (I have personally designed and implemented two solutions with this capability, one of which is still on the market.)

The one thing that should have been noted, but wasn’t, is that implementing these discounts usually requires a sophisticated set of binary equations. If discounts are required in bulk, the size and complexity of the model will increase significantly and this can negatively impact solve time in a big way.

In addition, not only are tiered and bundled bids the most common form of creative bidding supported by many optimization applications, but they are also the most powerful when combined with discounts and used appropriately.

Finally, there’s no reason that the optimization cannot be applied on-line, in real-time, during the auction. If you’re buying a commodity, or if you can completely specify your business rules and constraints up-front, you can run an optimization-enhanced auction and make (automated) contract offers immediately after the optimization completes. While most providers don’t yet have this capability, Trade Extensions, for example, does. Now, the model has to be of a size and complexity that can be solved in real-time during the auction, but thanks to the advances in processing power and solution algorithms that have materialized over the past five years, you’d be surprised just how big the model can get and still solve in the 15 to 30 minutes typically allocated for a mid-size real-time auction.

Next Part VIII: Challenges / Issues

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To Reduce Risk: Collaborate, Relate, Invest, & Optimize

A recent Inside Supply Management article on “The Global Reality of Geopolitics” noted that terrorism, war, disease and political unrest are just some of the geopolitical pressures that supply management executives face today. The geopolitical risks for most multi-nationals are increasing daily, and most of their supply chains, which still assume flexible JIT models will always be possible, are still not prepared.

To prepare your supply chain, you need to identify, assess, and put a mitigation in place for each likely or significant threat. One way to assess the threats, according to Celina Realuyo of CBR Global Advisors, is to look at its impact from a space, time, and depth perspective. With globalization, unless multiple countries adopt the same protectionist measures, there are no boundaries. As a result, disease outbreaks can spread rapidly around the globe. Today’s marketplace is 24/7. As a result, most leaders are in response mode instead of strategic planning mode. A problem usually produces multiple instantiations as it ripples through the chain. Thus, a solution that solves a second level effect may not solve the base problem. Thus, if a problem is unrestricted by boundaries, relevant to the market, and related to manufacturing, it’s probably significant as its repercussions could quickly spread throughout the supply chain. Another way to assess threats is to consult experts to assess severity and likelihood.

So how do you mitigate the threats? According to the article you:

  • Collaborate with the C-suite
    It can be extremely difficult to price and protect against certain types of (geopolitical) threats, so you need all of the experts in the room who understand the potential repercussions. To get them, you’ll need the C-suite’s support.
  • Invest in Expertise
    If you don’t have risk experts in-house, get them. In the interim, bring in consulting experts to help you.
  • Establish Local Relationships
    You need to work with your suppliers to identify all of the relevant geo-political and location-based threats, their potential impact, and their potential likelihood. Otherwise, you could be panicking for no reason or ignoring a potentially explosive situation.

And it’s not a bad start. However, I was really disappointed that there was no mention of Optimization, which is very relevant in risk analysis. You see, where risk is concerned:

  • You’ll never be able to mitigate all the risks.
  • You’ll never have enough money to implement all of the mitigations you identify.
  • You never know precisely when a risk might materialize or how much it will really cost.
  • No matter what you do, you’re still going to experience disruptions.

Thus, the only way to come up with a mitigation plan that’s going to truly minimize the cost of future supply chain disruptions is one that uses simulation, modelling, and optimization. Now, it’s true that there’s very few solutions on the market to help you at this point, but it’s where you need to get to. Decision Optimization isn’t just for Logistics, Sourcing, and Supply Chain Planning. It’s for much, much more.

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Reverse Auctions Are On The Rise Again … Is This A Good Thing?

CAPS Research just released a snapshot on the “Use of Reverse Auctions” which illustrated that more organizations are using reverse auctions and that their usage is on the rise at almost half of the companies currently using them. Specifically:

Are you currently using reverse auctions? Yes 50%
No 50%
(Yes) Has the amount of spend through reverse auctions over the last two years …? Increased 46%
Decreased 26%
Stabilized 28%
(Yes) Do you plan to continue using reverse auctions? Yes 100%
No 0%
(No) Have you previously used reverse auctions? Yes 46%
No 54%
(No) Do you expect to start using reverse auctions within the next two years? Yes 29%
No 71%

In short, 50% of companies are using reverse auctions, 15% more plan to start in the near future (29% of 50%), and close to 25% of companies (46% of 50%) are pushing more spend through reverse auctions than they used to. So, not only have reverse auctions received a passing grade (65% of companies are giving them the thumbs up), but they are being graded on a steadily rising curve. Believe it or not, this scares me.

While I will gladly admit that they have their place (especially for small or non-strategic commodity buys where the savings associated with another, more strategic, type of sourcing event would not outweigh the manpower, system, and opportunity costs to support the more strategic sourcing event), they are not the savings panacea that some vendors and consultants make them out to be. While it’s true that it’s rare not to see a landed cost reduction the first time you run a reverse auction if you run the event properly, it’s also a rarity to see repeated cost reductions on the same category in future reverse auctions (unless the production cost or market value of the commodity in question is falling at the time) because all a reverse auction does (when successful) is take fat out of the supplier’s margin. (And if you don’t pre-qualify your suppliers, it might also take quality out too!)

The fact of the matter is that real, sustainable, cost reduction comes from product and supply chain optimization and innovation. That’s why strategic sourcing decision optimization not only delivers a cost reduction of 12% above and beyond what a reverse auction delivers but also delivers cost reductions on repeated applications.

In other words, you should continue to use reverse auctions where they make sense, but only where they make sense. Otherwise, like many of the early adopters who had high hopes, you might be very disappointed.

And yes, for maximum benefit you should combine their application with decision optimization, which I’ll address on Monday with Part VII on The Role of Optimization in Strategic Sourcing.

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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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