I am the CFO of Tevper Performance Products, a large, multinational manufacturer of industrial equipment. Tevper sources hundreds of thousands of components, materials, and services every year, which account for billions of dollars. The VP of procurement and I have convened a team to review and improve our purchasing practices throughout the organization.
The impetus for the review was discovering that we are literally leaking money by not fully leveraging our purchase volumes and buying power. I don't expect all of our 13 production locations to source in an identical manner: Many have total-cost formulas that are best served by tapping into local suppliers. Others require nearby sourcing to reduce lead times. Some are constrained by how and what their outsource manufacturers choose to purchase. But even after lightly scratching the surface, I see countless missed opportunities for Tevper to lower our costs for direct and indirect materials. For example, at our Arizona location, I can find a variety of suppliers, product numbers, product names, and pricing for the exact same component. This must stop.
In my five years at Tevper, we've taken a light hand toward strategic sourcing, believing that well-trained, local procurement departments would make the right decisions: implement sourcing processes and systems that enable them to understand, aggregate, and control procurement activity that is occurring within their location or division as well as make purchasing decisions consistent with other business units. I have respected their autonomy, but cannot afford to do so any longer.
The VP of procurement, the review team, and I must, first, uncover the most egregious purchasing problems and put an end to them as quickly as possible. But, more importantly, we need to begin developing the means and systems that allow comprehensive and real-time tracking and reporting required to achieve high levels of purchasing performance even within our diverse and distributed business model. It will be a challenge, and, as word has leaked out, I am seeing the emails stream in: "Our supplier relations are unique," "You'll never get our purchasing data to be compatible," and "We don't have time to make every purchase align with corporate mandates."
I don't have time for their excuses. And my future with Tevper may rest on my ability to install a major strategic procurement program. Can it be done?
* The Challenge incorporates hypothetical persons, companies, and products and does not portray the actions of any actual persons, companies, or products.
By Corey Billington
To begin creating an outstanding procurement organization, consider your business model and resulting supply chain strategies, and then develop processes and supporting purchasing structures that allow everyone to understand and align with the business model. A supply chain strategy can be defined by how choices and investments are made in the management of three primary flows (materials, information, and money) and three secondary flows (risk, relationships, and ideas). The procurement organization affects all of these flows.
Your procurement organization should align the organization around creating and exploiting competitive advantage, sometimes called "earned preferential treatment." The most important thing that a CEO or CFO can do is to expand the measures and KPIs (key performance indicators) of the procurement organization to focus on competitive advantage and the ability to create economic advantage (rather than focusing solely on price).
Once new KPIs have been established that focus on competitive advantage (e.g., total cost of purchase, including costs of holding inventory), then go one step further and consider competitive purchase price, the risk of supplier shortages, the wastes involved from having a supplier at all, and the cost of supplier relationships. These are harder to assess than total cost (which itself is not easy to nail down), but should take into account the risk-adjusted, whole product cost (price adjusted for risks such as availability) and the transaction economics (cost of relationships and the waste created, e.g., cost of the bullwhip effect).
So how do you begin?
- After changing measures and KPIs and freeing the procurement organization from the tyranny of price, implement a supplier perception process (e.g., supplier ombudsman) and start asking suppliers the questions, "What behaviors do we have that cost you money? What behaviors cost us money."
- Build "should-cost" models for the most promising categories. This allows you to identify the purchase categories that have the most supply chain waste, as defined as the difference between what a good or service should cost and what it does cost the organization. The difference between the "absolute best cost" (ABC) and the actual total cost allows you to sort purchase categories by potential for creating economic value. For commodities, the market price is typically the absolute best cost, but fewer things are commodities these days.
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Segment purchase categories into four groups:
- Lowest-price-based categories (commodities) under control,
- Commodities not under control as gauged by a formula of price – ABC,
- Value-based categories under control, and
- Value-based categories not under control as gauged by a formula of price – ABC
- Measure your local procurement and management on their progress to closing the price – ABC gap for commodities not under control. Local procurement groups will quickly discover that the easiest wins are to bring the price of locally procured materials, components, and services in line with the best price currently available in the company. Next, create a process to ensure that these commodities stay in control (i.e., in step with market prices).
- Use relationship-building to improve the value created and loss for the value-based categories. Work together with your suppliers in these areas to remove waste and maximize competitive advantage. Cost models can be used to focus performance conflict on reducing waste rather than fighting over margin when this is the best approach, pointing to long-term benefits for both you and suppliers.
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
Segmentation is key when deciding how best to reorganize procurement. And politics will always be an issue when trying to balance flexibility at the factory vs. control from headquarters, perceived or otherwise. Even within a factory there will always be the conflict between the expediency of satisfying a particular order and the need to follow established purchasing contracts and delivery schedules.
I suspect these are the key conflicts experienced at Tevper, which has resulted in the situation you describe. Process discipline needs to be enforced, but flexibility of decision-making needs to be part of the process. If not, maverick behavior will begin to take root, resulting in inconsistent part numbering and inconsistent purchase contracts with the same suppliers for a facility and across facilities.
While process is important, equally important is buy-in by senior management so that they enforce process when expediency seems to be the most reasonable course of action. This can only be achieved by hard facts. Analysis should be carried out not only to show that maverick behavior occurred, but to also calculate the cost of the maverick behavior in financial terms and, in particular, margin erosion.
The analysis needs to be understood in the context of product lifecycle and importance of the demand that initiated the maverick behavior. In the early stages of a product lifecycle, market share is often more important that margin capture, whereas in the late stages of the product lifecycle, margin capture is more important than market share. In addition, demand is more difficult to predict in the early stages of a product's lifecycle than in the late stages, so the likelihood of running out of raw materials or components is greater. As a consequence, some level of short-term maverick behavior can be tolerated in the early stages of a product's lifecycle, but corrective action should be put into place immediately to correct this before it becomes routine.
In the later stages of a product lifecycle, demand is more predictable and the threat of excess and obsolete materials is real. In addition, because of normal price erosion over a product lifecycle, the margin is likely to be quite low. Any maverick purchases or excess and obsolete inventory is likely to erode the margin completely. As a consequence, strict adherence to purchasing process should be enforced during this period.
From the perspective of negotiating with suppliers, it is important to get not only an understanding of the total spend with a particular supplier, but also to get a good feel for the projected total spend with a supplier. The projected spend should be further segmented by projected total revenue impacted and the product lifecycles that constitute the projected total demand. In this manner, concessions can be made on price and delivery — lot size and lead time — for components that are deemed to be of greater importance because of revenue affected and/or lifecycle of products affected. Obviously, fewer if any concessions should be made on price and delivery of the components of lower importance.
As alluded to earlier, the true conflict and root cause of less-than-optimal purchasing practices is not between centralized or local procurement, but between the purchasing department and manufacturing department. Inevitably, performance measures are in conflict: purchasing being measured principally on component price and inventory levels, and manufacturing being measured on delivery performance — on time in full — and margin. Providing a system that allows these conflicts to be discussed and negotiated is key to getting buy-in on a day-to-day basis. While historical performance is good for discussions with suppliers, projected information based upon anticipated demand is more important for the discussion between purchasing and manufacturing. History cannot be changed, and only looking at history will lead to finger pointing. The future is what can be affected and is where compromises can be made and conflict avoided.
The good news is that these systems exist. In times of supply shortages, these systems will identify the revenue at risk and provide a collaborative environment in which manufacturing and purchasing can evaluate alternative scenarios to assess the consequences at a financial and operational level. In addition they will identify purchase avoidance opportunities where excess material at one location can be transferred to another location, which is about to issue a purchase order for the same or equivalent material.
Trevor Miles is director of industry and applications 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 as 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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