I commented recently on the “Measuring Inventory Performance“ article in Supply Chain Digest on ways of measuring the efficiency and effectiveness of the supply chain. In the article I argued that Purchasing/Procurement has a direct effect on the manner in which the supply chain can be operated effectively and efficiently. In fact, that the contracts entered into by Procurement are as much of a constraint on the supply chain as are physical constraints such as machine capacity and plant layout. These effects are felt in both the long term and the short term.
Many who work in product design often comment that over 80% of the cost of manufacturing a product are determined during the design and procurement phases. This is a number with which I cannot argue. Clearly many of these costs are determined by decisions made by the design team, such as which materials to use for a component. However, best design practices I have come across are a well choreographed dance between the design engineers “creativity” and procurements “pragmatism” in which processes and incentives are put into place to encourage the design team to, in order of priority:
- Reuse an existing item purchased from an approved supplier
- Design a new item that can be purchased from an approved supplier
- Design a new item that needs to be purchased from a new supplier
Clearly this process is designed to reduce the costs – which can be considerable – of acquiring a new supplier. While the description above deals with the design of a new product, a great example of how R&D and Procurement can work together to reduce supply chain costs for existing products was presented in a webinar titled “Radically Simplifying The Supply Chain To Facilitate Growth – Learn From Best Practice In FMCG” (paid registration required) by Hans Droge, SVP of R&D at Unilever on SCMWorld. The emphasis of Hans’ presentation was the rationalization of product families to reduce the complexity of manufacturing and purchased materials. He made a great distinction between product diversity, which is visible to the customer, and supply chain complexity, which is invisible to the customer. The benefits of the exercise Hans highlighted were:
- Rapid roll out of innovation due to fewer plant trials and factory clearances
- More flexibility in product sourcing; stronger contingency options
- Lower capital expenditure from consolidated buying
- Harmonising of machinery training courses
Throughout the presentation Hans emphasized how Global Purchasing, Brand Development (Marketing), Supply Chain, and the operating companies (Sales) were all brought together in order to balance the competing needs of product diversity while reducing supply chain complexity/cost. What was very clear in the presentation was the active role that Global Purchasing plays in reducing supply chain complexity and therefore cost. One benefit emphasized by Hans is the reduction in purchase price that can be achieved with consolidated procurement. By rationalising the purchased materials and the suppliers, the quantities purchased from each supplier increase dramatically providing great leverage to the purchasing organization. This benefit is only available with consolidated procurement through a global procurement function.
While this is a great example of how to reduce supply chain complexity and operating costs at a strategic and tactical level, as we all know from our daily lives, there are plans and there is reality. The product rationalization described above was based upon a set of assumptions of market conditions, demand patterns, and supplier capabilities which are unlikely ever to be completely correct. However, decisions made at the strategic and tactical level constrain the supply chain to a fairly narrow range of efficiency and effectiveness at the operational and execution level. As stated earlier, a rough rule of thumb is that 80% of the costs are determined during the design of the product and the supply chain level, or determined by the contracts entered into by Procurement.
Faced with late orders or idle equipment, every manager‘s instinct is to do the expedient rather than the expeditious, solving the immediate problem but perhaps creating additional longer term problems. Typical of the expedient is to purchase materials from a supplier with which there is no long term relationship, agreed pricing, or agreed delivery. As a onetime response this may be the right thing to do, but all too often this “maverick” buying becomes a pattern, negating the benefits of consolidated procurement. In fairness, this behaviour could be a result of the market conditions changing to the extent that the original purchasing contracts and conditions are no longer valid. A strong consolidated procurement capability should be able to detect these situations and adjust the contracts appropriately. Alternatively, the solution could be as simple as planning around the constraint by carrying more raw material inventory. This will result in higher carrying costs, but these costs are likely to be smaller than the increased purchase price resulting from maverick buying.
In summary, consolidated procurement contributes to reduced supply chain cost in many ways. Focussing attention too narrowly on the metrics of any one function, such as supply chain, can reduce the efficiency and effectiveness of the supply chain as a whole. Yet the supply chain needs sufficient flexibility to balance the competing needs of satisfying all demand and doing so at the cheapest cost. Supply contracts negotiated by central procurement can reduce supply chain flexibility greatly.
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We received a tweet from No1ofCnsqnc asking about increased risk in a recent post on consolidated procurement. While No1ofCnsqnc is correct that I did not address the question of risk, I do not see how having consolidated procurement increases risk. And what risk in particular? In my original reply to the article in Supply Chain Digest I point out that supply contracts are as much a constraint as the physical equipment on the factory floor. I also bring out the risk of entering into a long term supply contract which over time constrains the supply chain in a negative manner because the new business conditions call for different terms. The other supply risk that is mentioned often is single sourcing. While I suggest that consolidated procurement can be used to reduce the number of suppliers, I would be the first to suggest a multi-source purchasing strategy. When a central procurement/purchasing organization does not exist or when “maverick” buying is very prevalent, the reality is that most manufacturing sites adopt a single source strategy because they are doing the expedient rather than the expeditious. From a corporate perspective it may look as if there are many suppliers, but there is no way to leverage this at a manufacturing site level because each site does not know the other suppliers. In this context there are many points of failure.
Nevertheless No1ofCnsqnc makes a valid point. My original reply to the article in Supply Chain Digest advocates for a bigger role for supply chain in the establishment of supply contracts in order to address more than the price and payment terms in the contract.
Thanks for the menton and I really enjoy your writing. I guess I misunderstood what you were saying, when I mentioned risk I was really addressing single source strategies which are frought with unnecessary risks.
When talking about the global supply chain single source aggregation can substantially increase the risk of supply interruption given global weather, shipping, geo-political and wild card conditions.
As an anecdotal point, how do you think manufacturers that aggregated their supply into Mexico are feeling about the risk in that decision right now?
Aggregation can be incredibly effective, but only in concert with contingency and/or multi source supply plans.
Here’s a question. Do you really believe “maverick” spending can be stopped in a manufacturing environment?
No 1 of Consequence
All very good questions, so please keep the dialog going.
No decision is without risk. I understand that there is a pharmaceutical in short supply becuase one of the manufacturing steps requires a chemical that is a bi-product of a certain manufacturing process in the automotive industry. There are a lot of layers to my previous sentence, not the least of which is the fact that the sole source for a key is a bi-product of an industry in decline. Who would have been able to predict that at the time of setting up the supply contracts? Given that it is a bi-product, it would be tough to make the chemical at a cheaper price, so procurement would have been asked a lot of questions about a more expensive sourcing strategy at a time when the chemical was plentiful.
That there is an outbreak of swine flu is Mexico doesn’t change the long-term cost advantage of sourcing from Mexico. The same issues can occur in the US. What about the salmonella in peanuts? What about the earthquake in China? I don’t think there is a risk-free sourcing strategy. I think what needs to in place is not only risk mitigation, but also risk response. How quickly do you know when an unforeseen event occurs that will cause harm to your supply chain, and how quickly can you respond? I don’t think any and all risk can be “designed” out of the supply chain.
Similarly, “maverick” spend is always a potential issue. I would distinguish though between spot-buying and “maverick” buying. Spot buying is an structured process for buying materials from a supplier off contract. “Maverick” buying is the deliberate subverting of purchasing and supply chain processes, usually to achieve a local target while under-cutting wider targets. SO I do not believe “maverick” buying can be stopped, but I do believe it should be minimized and that there should be strong incentives (or simply an alignment of metrics) to achieve this.