Thrykes Power has been fortunate to weather the recession. We design and manufacturer two- and four-stroke carburetors for consumer- and commercial-use engines. Many of our recent product introductions are, fortunately, in growth markets such as low-noise and low-emission carburetors, and so we've been able to keep all our plants open and retain the vast majority of our workforce (with some reduction through attrition). But we, like many, have struggled to sustain our profit margins, and we've increasingly looked at all aspects of the company for cost savings. Doing so, we ran head into a procurement mess.
In the past five years we've had a number of executives oversee our procurement operations, some promoted up and some exiting the company. Unfortunately the turnover was rapid and none really put their stamp on a purchasing strategy, one applicable for our headquarters, plants, warehouses, and sales and marketing offices. Lacking any real mandate for central oversight — for components and materials, indirect spend, and support services — we've got dozens of policies by location and department and dozens of problems:
- No leveraging volume purchases; it's as if everything we've been buying, goods or services, is a one-off.
- Incredible data garble of naming and numbering schemes for procured goods and services, making it difficult to even accurately see our volume of purchases.
- No review, followup, and management of suppliers based on performance; we have not been punishing bad quality and delivery and, similarly, we've not been rewarding our best suppliers, some of which have moved to our competition.
- Lastly, with so many rogue procurement locations, we've got a lot redundancy of inventories and MRO throughout our plants. For example, we can get a machine part to any location within six hours, so why has every facility treated all their MRO inventories as "critical and must have in stock."
Thrykes' need to manage procurement is obvious, but with tens of thousands of purchases annually, we are overwhelmed by the volume. Where to begin?
* The Challenge incorporates hypothetical persons, companies, and products and does not portray the actions of any actual persons, companies, or products.
By Corey Billington
Five years before I took over the management of the central procurement group at Hewlett-Packard (HP), the department had been considered an outstanding contributor to the company. It had received numerous awards and accolades, including the coveted medal of excellence from Purchasing magazine. Its leadership had been greatly admired, and internal departments had viewed the procurement team as high-performing, providing good value, and helping them meet their business objectives.
However, at its pinnacle of success, the head of central procurement left HP taking several key staff with him. The next few years saw the central procurement group go through a lack of leadership and loss of focus and direction, and many employees left the organization, leading to a situation much like the one you describe at Thrykes.
Central procurement's internal contribution was being disputed by the operating units, which were lobbying for the department to be disbanded. I knew that if procurement was decentralized, overall purchase costs would continue to rise as they had been for a few years, the complexity and costs to suppliers that sold to multiple parts of HP would increase significantly, product development would be slower and more difficult, and overall customer satisfaction would suffer. I am a fundamental believer in the power of collaboration, and I wanted to get this group back on track and functioning at a high level before disbanding became a real option.
I made a number of internal organizational changes. For the purposes of assisting Thrykes, I will focus on those involving central procurement's interaction with the product organizations. Of course, this was a team effort in which central procurement management played a key role in both setting policy and the implementation of policy.
My philosophy was that there was a direct link between central procurement's budget and its customers, the independent product organizations, which have P&L responsibility. Previously, central procurement was a tax item on the product organizations' P&L statement. This had left many line executives grumbling that they were paying for services they deemed of little value and that they were being charged for things they did not use. The value was not transparent, and no accountability was created.
We decided to change this mindset and gamble that if central procurement used a fee-for-service model, it could actually increase its value and budgets ("revenues") while improving P&L "customer" satisfaction and impact the company's overall value and innovation. We structured new levels of service to be offered to P&L "customers" depending on their needs. Fee-for-service made their value transparent and the structure gave my managers a high degree of accountability, thus providing the P&L organizations a way to ensure that they were getting value for their money. I used this structure to motivate my staff and reinforce the strategy that they had to make their services valuable in the eyes of the P&L managers — not just senior management — and that there was no such thing as a "free lunch."
We discussed this new approach with the product organizations and got their reactions before we made a complete change to the way we charged them. I also made sure that there would be enough business to keep the group viable. One of our earliest meetings was with the recently appointed head of a product organization that represented a significant portion of HP's total size and paid central procurement a substantial amount each year. We knew this would be a strategic meeting. If central procurement could partner with this organization and rebuild its credibility, illustrating its value within the rest of HP would be that much easier.
The newly appointed head had been very vocal in the internal debate of the need for central procurement. He was a fan of decentralized procurement, and was making plans to eliminate the budget for central procurement over the next four years. His belief was that there had been little value-add, just cost.
We engaged his managers in discussion, broke down all the services that central procurement had been providing, and got his managers to provide examples of where central procurement had helped them meet their objectives. Once the head of the product organization heard how his team had benefitted from central procurement's services and learned more about what we were proposing, he increased services by 10%.
Experiences like these became the model of how I wanted my team to structure the value they brought to internal customers, and, ultimately to the organization as a whole. The central procurement team needed to create a value system that was transparent, not one that was viewed as only a resource consumption system.
After four years, HP's central procurement group was back on top, and once again won the Purchasing medal of excellence (HP was the only company ever to have won twice). Central procurement was providing value and helping product organizations meet their business objectives. There is no reason to believe that central procurement at Thrykes Power cannot do the same.
Corey Billington is Professor of Operations Management and Procurement at IMD (www.imd.ch). A pioneer and leader in supply chain innovation and procurement practices, professor Billington was Vice President of Supply Chain Services at Hewlett-Packard (HP), where he managed procurement and central engineering. He guided a team of 1,400 professionals with expertise in procurement, engineering, tax design and cost management. Among his previous roles, he was Executive Director of Strategic Planning and Modelling, serving as a key pioneer of HP's approach to supply chain management. In addition, he also managed a design company with clients in consumer goods, high-tech, and services. He was a consulting Associate Professor at Stanford University's School of Engineering in the department of Management and Engineering. His interest in supply chain management began in the early 1980s during research toward his PhD in industrial engineering and engineering management at Stanford University. Before the term "supply chain" become common vocabulary, he was inventing techniques for supply chain improvement and predicting the widespread trend toward increasing profit margins through effective supply chain management. He can be reached at corey.billington@imd.ch
By Trevor Miles
There is no doubt that much of the issue at Thrykes Power is down to management effectiveness. Little will be achieved without strong management in central procurement that has executive support. By now the acceptance of the value of central procurement by the divisions and manufacturing plants is probably very low. Indeed, it is difficult to persuade a plant manager that some key performance indicator, such as plant utilization, will be missed because of a shortage of parts managed by central procurement. But it is important to understand that this scenario is likely a failure of a process rather than a reason not to have a central procurement organization.
Thrykes Power should focus central procurement on direct materials (those used in production to manufacture the finished product) rather than on maintenance and repair parts (MRO) or strategic items such as new capital equipment. While central procurement will have a big impact in all purchasing areas, getting direct materials under control will provide benefits very quickly. However, the political battles will be most charged with direct materials because of the impact they have on finished-goods availability, plant utilization, inventory levels, and gross margin.
To be successful, Thrykes Power needs to:
- Start by identifying the short- and long-term objectives of spend analysis tools and prioritizing those objectives to focus on highest return benefit. As noted, start with direct materials. It is important that Thrykes Power approach this from a continuous-improvement perspective. You should not assume that this will be a quick process, and, therefore, you need to focus in the short-term on the things that have the biggest impact to the business. For political reasons you may want to start addressing issues that the manufacturing plants or finance department have identified as issues. In the long-term, Thrykes Power should focus on the design process to ensure the reuse of commodities and the use of key materials from an approved vendor list.
- Make sure the manufacturing plants/finance have agreed to the short-term goals. The success of a central procurement organization is dependent on the buy-in from the manufacturing plants. Without a doubt strong executive support can assist greatly, but at the end of the day central procurement must provide tangible and recognized benefits to customers in order for their processes to be followed by manufacturing. Unless the goals are agreed in advance, central procurement will always be trying to justify its existence.
- Use benchmarks as evidence of improvement potential. While no two companies are exactly alike, being in the lower quartile of some key metrics is a clear indication that the current way of doing business is inefficient and ineffective. Focus on a few key metrics across all direct materials, and then refine those metrics for the materials with the greatest impact to the business. Focus on the revenue impacted rather than the cost of purchase. For example, a fairly low cost item that accounts for roughly 10% of spend may be used in finished goods that account for about 90% of Thrykes Power's revenue. Use only a few key metrics that highlight the issues, such as the number of suppliers for an item and the number of locations at which it is stored/used.
- Start with trusted data. Start with categories central procurement already manages and knows well. This will help the team to gain confidence and to ensure processes and data are accurate. If a tool is brought in to facilitate the process, these categories can be used to develop the skills required within central procurement.
While some of the suggestions above appear to conflict with each other, it is important to understand that some are directed at getting buy-in from central procurement's internal customers, while others are directed at developing skills within central procurement. When in doubt, central procurement at Thrykes Power should focus on satisfying the needs of their internal customers.
The opportunities for cost reduction, some of which you have identified in stating the problem, are:
- Commodity prices: While this effort should be focused on commodities, there are opportunities to decrease the prices for some key components, too. By getting a better understanding of the total spend with a particular supplier, Thrykes Power could negotiate lower prices across all parts supplied by that supplier. In addition, Thrykes could decrease the supply base so that they can direct more volume to fewer suppliers and negotiate a lower part-price based on the greater volume. Given the current state of Thrykes' data, this is not a trivial task, but one well worth the effort. By segmenting the direct materials by purchase volume, Thrykes Power will be able to identify some quick wins rather than waiting until the data is perfect before evaluating the opportunity.
- Transportation costs: Since it is likely that Thrykes Power sources some of the direct materials from China and other countries in Asia, having each facility order from suppliers separately could result in transportation costs that are significantly higher than they should be. Lower transportation costs are achievable without supplier and part number rationalization and therefore should really be treated as "low hanging fruit." Consolidating orders into full container loads will likely require some adjustment of the delivery dates, which may result in higher inventories, but the decreased transportation costs can be much greater than the increased inventory cost.
- Inventory levels: Because each location is maintaining its own inventories, each requires its own safety stock. Using a central warehouse for commodities purchased by many of the manufacturing plants will greatly reduce the safety stock required, and also help to reduce excess and obsolete inventory as well. Of course this can also decrease expedite costs significantly by having a larger central pool of inventory from which to draw, rather than requiring an emergency order from a supplier to a particular manufacturing site. The extent to which Thrykes Power will be able to decrease their inventories depends on the geographical dispersion of manufacturing facilities and the commonality of parts used across the manufacturing sites. Interestingly, Thrykes Power has already indentified a central warehouse as a way of increasing the availability while reducing the inventory costs of MRO parts. This principal can be applied to commodity parts and to key materials that are shared across several manufacturing sites.
The benefits of using central procurement effectively can mean a 15% or greater increase in gross margin. For Thrykes Power, the benefits are likely to be greater and therefore should not be ignored.
Trevor Miles is director of product marketing at Kinaxis (www.kinaxis.com), and is responsible for identifying market trends and translating these into high-level functional requirements for the company and opportunities for value capture by Kinaxis customers and prospects. Prior to joining Kinaxis, Trevor worked for i2 Technologies, where he held a number of sales and marketing roles and worked with global industry leaders such as Continental, Volkswagen, Nokia, and Thomson. Previous to i2, Trevor worked for Coopers & Lybrand performing several studies in supply chain reengineering for companies such a Levi's, Burmah Oil, TNT Logistics, AGA Gas, and Schneider Electric. Trevor has degrees in Chemical Engineering and Industrial Engineering. He can be reached at tmiles@kinaxis.com
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