Friday, March 25, 2011

Cost Management Programs

Procurement has seen a number of changes and new programs that have come into vogue. Some started with a huge fanfare and ended quietly with relative degrees of success. Others have become more ingrained in what you do and how you do it. Virtually every one of these programs has a goal of reducing cost. They seek to either:
1.     Reduce certain costs;
2.     Eliminate different investments, which reduce the cost associated with those investments; or
3.     Reduce the resources and expense of managing the procurement of goods and             services.

Let’s look at each strictly from a cost perspective at what the cost goal was:

 JIT / Kanban, Pull Replenishment.  A pull replenishment, JIT or Kanban program is designed to reduce the inventory levels a Buyer must carry and push the cost of carrying and managing inventory back to the supplier. This reduces the Buyer’s investment in inventory and other potential inventory related costs such as space, risk of loss, obsolescence.                     
Supplier Certification. Supplier certification is a method by which Suppliers are evaluated to ensure they have the requisite capability and processes to consistently provide products of high quality. A goal of Supplier Certification is to eliminate the Buyer’s incoming inspection activities with those Certified Suppliers and the resultant cost.                                                                    
Six Sigma. A Six Sigma process is designed to reduce or eliminate defects that occur which in turn reduces the costs associated with those defects. The reduction of defects can be targeted to reduce the cost of manufacturing or other processes. For example, if the quality or a product can be substantially improved, it allows you to reduce the costs associated with poor quality such as carrying additional inventory, increased inspection, rework and scrap costs. Eliminating a defect that causes reliability problems further reduces field costs such as spare parts and repairs inventories, or field service calls.
Benchmarking: Benchmarking is the method by which you compare prices, processes against other Buyer’s with the goal of identifying where there may be opportunities to reduce prices or reduce the costs associated with the process. The cost goal of Benchmarking is to identify where savings to either parts prices or processes may be made to reduce cost.
EDI: Electronic Data Interchange is a method by which orders, changes, etc. are communicated instantaneously, and reducing the impact that delayed communications could have on inventories, cancellations, forecasting, and flexibility. Etc. The cost goal of EDI is to eliminate the cost and errors that can occur with manual ordering processes. It also reduces the time to react to orders, changes etc., where delays can mean additional inventory or liability.
Total Cost: The concept of “total cost” was to create an understanding that there are a number of factors, other than price, that effect the cost of a supplier relationship such as the cost of inventory, cost of quality, other performance related costs, and other costs of doing business with a specific supplier, supplier’s terms, supplier’s business process and requirements or performance. The cost goal of Total Cost is to make sourcing decisions based on the total cost, thereby reducing the total cost, or using those total cost factors to improve supplier performance or cost reductions to offset the incremental cost of doing business with that supplier.
Strategic Cost Management: In many companies the concept of Strategic Cost Management was a signal of their intent to move away from reliance on the competitive bid process as the primary method of selecting suppliers, to a negotiation process in which individual segments of the supplier’s cost are negotiated with the help of detailed costs estimates by cost engineers and consultants, competitive benchmarks, analytical formulas, etc. The cost goal of strategic cost management is to ensure that you purchase at a competitive cost with lesser impact from the marketplace and also facilitate early supplier involvement in programs where their expertise may further reduce the cost of the design or manufacture of the product.
Strategic Supplier Management, Alliances and Partnerships: While all these programs are designed to build a closer relationship with supplier so that thing like early supplier involvement may occur, most of these programs also recognize the fact that Power and Leverage changes as the situation changes which can impact you cost. If the Supplier has the power, you pay more. If you have the Power through competition, you will pay less. If you create strategic suppliers, alliance or partnerships, one of the cost goals is reduce the impact of changing leverage in favor of more consistent price formulas that are designed to provide the supplier with a reasonable profit, while consistently providing the Buyer with competitive cost. 
Credit Card Purchases: Credit Card purchase programs were designed to not so much to reduce the cost of the product as much as it was to reduce the purchasing and accounts payable infrastructure associated with procurement of low value items. While some cost improvements may occur through creation of limited product menus and limited suppliers, the real cost savings occurs through the elimination of the transactional activity associated with those low value orders and either the reduction of resources or the focus of those resources on higher value added work such as negotiating volume purchase discounts with the preferred suppliers.
Supplier Reduction Programs: Supplier Reduction Programs were designed to reduce the number of suppliers which the Buyer did business with to both eliminate all the costs associated in managing the supplier, but also to combine the volumes purchased with other suppliers to leverage better pricing on the higher volume. When supplier reduction programs are managed in a manner where the primary goal is to reduce the number of supplier and not reduce them to increase leverage, a Supplier Reduction Program can have a negative cost impact by reducing competition.        
TQM: TQM or Total Quality Management programs were focused on improving the quality of the products purchases. From a cost perspective, improving quality will reduce Buyer’s costs that were associated with problems with Supplier’s quality. Cost reductions can occur in the elimination of incoming inspection and its associated costs, reduction in inventory levels associated with quality levels, reduction or elimination of cost of quality which occur because of in failures in process (such as re-work costs) or failures which occur in the field (Spare parts and repairs inventories, field service calls, etc.).           
Early Supplier Involvement: The concept of early supplier involvement is to involve suppliers in the early stages of the design process to use their expertise. The cost goal of Early Supplier Involvement is to use the Supplier to help design a more cost effective product; use more cost effective materials; or help design the product for lower costs of manufacture, service, etc.
Outsourcing; While there are many reasons why a Company may decide to outsource, the reasons most frequently mentioned are: to focus investments on core competencies with higher returns on the investment; to avoid making new technology investment; improved efficiencies; greater flexibility and less risk from a manpower perspective; reduced costs because of the outsourced partner’s buying power; reduced labor costs from using operations in lower labor cost areas, fewer business risks. With the exception of focusing resources on core competencies that is designed to yield a higher return on investments, all the others are focused on reducing cost directly or the potential cost associated with certain risks.   
Vendor Managed Inventory:  Vendor Managed Inventory takes pull replenishment or JIT activities one step closer, with the Supplier actually providing the inventory directly to the Buyer’s site and managing the order / replacement based upon a combination of the Buyer’s forecasts and pulls from the on-site inventory. The cost goal in this is once again to eliminate inventory carrying costs and all costs associated with managing the inventory (space, utilities, insurances, damage, shrinkage, obsolescence, and shelf life obsolescence).
Supply Chain Management: The initial goal of supply chain management was to speed up the supply from suppliers to customer to make companies and their suppliers more responsive to the Customer’s demand. In doing supply chain management, the cost benefits were to reduce the level of inventory held at the different stocking locations, reduce the number of stocking locations, change product level ordering strategy or manufacturing strategies to focus on higher level assemblies to reduce the amount of movement of materials and subassemblies from location to location and their associated transportation costs. It was to select and implement strategies that optimized the supply chain’s speed and cost.  
Supplier Performance Scorecards and Measurements: The simple fact is that unless there is measurement, reviews, goals, and penalties or rewards associated with performance, Suppliers won’t make the efforts to improve, especially if they aren’t the ones bearing the cost. To drive change requires that they feel the same pain the Buyer feels and these types of programs are designed to manage continuous performance improvement to reduce the associated costs.
Total Cost of Ownership:  In Selling Outsourcing Services such as Contract Manufacturing, Suppliers try to sell on what they call the Total Cost of Ownership which usually includes: Quality; Delivery Performance; Access to Competitive Manufacturing Technologies; Support Services; Competitive Pricing; and Flexibility. From a cost perspective TCO only addresses a portion of the real total cost of ownership that would include not just the total cost associated with the purchase, but also the life cycle cost of the product. 
Supplier Qualification: The concept of supplier qualification is for the supplier to technically qualify a product according to pre-agreed parameters. From a cost perspective, Supplier Qualification reduces the amount of investment the Buyer needs to make in such qualifications.
E-Procurement: There are a number of goals of E-Procurement. From a cost perspective, one goal is to reduce the procurement infrastructure required to manage the transaction process which frees up resources from that low value added type of activity (such as order placement) and allows you to eliminate them or focus them on higher value added activities which will reduce cost. Instead of placing the PO’s the resources should be negotiating the contracts and discounts that will be used in E-Procurement. A secondary goal is to take advantages of the electronic marketplaces that have been created to identify new, lower cost sources of supply.

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