Supply Chain Cost Reduction Strategies

Author(s):

Ralph G. Kauffman, Ph.D., C.P.M.
Ralph G. Kauffman, Ph.D., C.P.M., Assistant Professor, University of Houston-Downtown, Houston, TX 77002, 713-221-8962, www.dt.uh.edu, kauffmanr@dt.uh.edu.
Thomas A. Crimi, C.P.M.
Thomas A. Crimi, C.P.M., Senior Buyer, Texaco, Inc., Bellaire, TX 77402, 713-752-3981, crimita@texaco.com.

83rd Annual International Conference Proceedings - 1998 

Abstract. The concepts of supply chains and supply chain management are reviewed. Supply chain optimization is discussed and the strategy of supplier reduction is presented. Supplier reduction techniques including partnerships and alliances, integrated supply, JIT-II, supplier city, distributor cooperative, and lead supplier or supplier outsourcing are defined. When and how to apply these various techniques is discussed.

I. Supply Chains and Supply Chain Management. Supply chain management can be defined as an integrated approach to managing supply and distribution networks. In concept, it is the process of looking at the flow of materials involved in producing a particular product from their original raw material source, through the production process, and on downstream to the ultimate consumer. It can therefore include multiple tiers of suppliers and their suppliers and multiple layers of customers and their customers. Supply chains are simply the networks, or chains, of suppliers, producers, and customers involved in producing and marketing particular products.

The objectives of supply chain management include: management of the supply chain as a single entity, obtain seamless flows of materials, money and information throughout, reduce costs, reduce cycle time, reduce risk and uncertainty, and improve customer satisfaction. Characteristics that have been observed in managed supply chains include: a focus on total landed cost, sharing of information and risks among chain members, a means to measure improvement in chain performance, joint planning of supply systems and initiatives, fewer suppliers and transportation carriers, and minimum overall inventory investment. (Refer also to Ellram, 1994 for additional information on objectives and characteristics of supply chain management).

II. Supply Chain Optimization. The overall objective of supply chain optimization is to get the best possible performance from the entire chain as an entity. Some of the strategies to achieve that include: reduction of the number of suppliers, reduction of overall inventory in the system, improved packaging, handling, and transportation, reduced process cycle times, use of pull instead of push material supply systems. In this paper we focus on the supplier reduction strategy and discuss techniques that are useful to achieve reduced numbers of suppliers.

III. Supplier Reduction Techniques. Some of the techniques that various companies are using include: Supplier Partnerships, Supplier Alliances, Integrated Supply, JIT-II, Supplier City, Supplier Outsourcing, Distributor Cooperatives, and Lead Supplier. We will first describe the concept of each technique, its key elements, and generally how it works. Then we will discuss where and under what conditions each technique should be considered. Finally we will discuss application of the supplier reduction techniques.

Supplier Partnerships and Strategic Alliances. A supplier partnership usually involves using one supplier only for the supply of a particular material or service. It is not a partnership in the legal sense but is generally documented by a contract that describes in more or less detail the responsibilities of each party. Partnerships are usually entered for at least one year and often three, five, or more years. Strategic alliances have the same general characteristics as partnerships but in practice may be longer term and often involve more substantial investments in facilities or training by one or both partners and may include employees of either partner located in the other partner's facility to improve some facet of the supply operation. Compared to traditional transaction-type purchasing, Monczka, Trent, Handfield (1998) identify the following focuses of supplier partnerships, alliances, and other collaborative-type relationships:

Focus Area Characteristics of Partnerships and Alliances
Suppliers One or a few preferred suppliers for each major item
Cost Sharing Win-win shared rewards
Joint Improvement Efforts Joint improvement driven by mutual interdependence
Dispute resolution Existence of conflict-resolution mechanisms
Communication Open and complete exchange of information
Marketplace Adjustment Buyer and seller work together to adapt to a changing marketplace
Quality Designed into the product

Because of the extensive work involved in creating and maintaining a partnership or alliance relationship, it is not usually economic to have them for all purchased items. Purchases for which they are applicable include: large-cost items, items critical to the successful manufacture and sale of a product, items difficult-to-obtain or purchase, long lead-time items, and items for which the price is volatile (Handfield, 1993).

Integrated Supply. A common approach to integrated supply is to have one supplier take responsibility for all of the customer's materials management for a particular product line. This would normally include maintenance of whatever inventory is needed, warehouse operation, delivery to designated sites at or in the customer's facility, purchase of all items included in the integrated supply agreement. Some or all of these functions may be performed on the customer's premises or the supplier may keep some items on-premises and others at its own facility. The objective is to achieve the most cost-effective approach to meeting customer needs. The customer and supplier jointly determine what the best general configuration should be but the supplier makes all day-to-day decisions required to manage the supply process.

JIT-II. JIT-II is a technique that is applied where a customer has large usage of particular items and where continuous close cooperation between buyer and seller are required to meet the buyers needs. In this technique a person or persons employed by the supplier work in the customer's location as combination supplier salesperson/buyer procurement specialist for the items purchased from their employer. With the presence of supplier employees on the buyer's premises, communication and coordination activities with the JIT-II supplier are effectively optimized. A long term partnership or alliance agreement may be in place with the supplier. The Bose Corporation was a pioneer in the development of JIT-II (Dixon, 1997).

Supplier City. The main idea of the supplier city concept is to have one supplier from each of a number of purchased product lines co-locate in an location in close proximity to the buying plant or plants. This makes it possible for the suppliers to carry practically all of the inventory required to serve the buyers. The concept has some of the characteristics of integrated supply but suppliers are less likely to be operating on customer property and in customer buildings. Supplier cities also may include more product lines and multiple customers.

Distributor Cooperative. A distributor cooperative is an organization whose members are all separate distributors of various industrial products but who have agreed to cooperate with one another in inventorying and selling all the products they all carry. As a result, use of a distributor who is a member of a distributor cooperative gives a buyer access to all product lines and inventory carried by all members of the cooperative as if they were all carried by the distributor with whom the buyer is doing business. This reduces the number of distributors with whom the buyer needs to maintain relationships.

Lead Supplier or Supplier Outsourcing. The concept of a lead supplier is to select one supplier and give them total responsibility of supply for one or more product lines. Any products that are not normally carried by the supplier must be bought by them. In essence, the buying company outsources the purchasing and supply management of the items included in the lead supplier agreement.

IV. When to Apply Supplier Reduction Techniques. Not all of the supplier reduction techniques have the same potential for all situations. The following sections will discuss the general organizational and product circumstances under which each may be applied for maximum benefit. In some situations multiple techniques may be useful. For example, a supplier partnership or strategic alliance relationship can be used with most of the other techniques. How to determine where in a given supply chain to apply these techniques is discussed in section V. How to Apply Supplier Reduction Techniques.

Supplier Partnerships and Strategic Alliances. Items that should be considered for application of this technique can include: the largest cost component of the main product, the item that constitutes the differentiating feature of the product, the item that enables the main technical factor in the functioning of the product, the purchased item on which purchasing spends the most time, the most difficult item to obtain, the item with the most volatile price, the item with the longest lead-time (Handfield, 1993). In other words, items with high impact of the operation, either in terms of dollars or in criticality to the product being made.

Integrated Supply. This technique is most often applied to a supply situation where there are large numbers of products purchased from a particular product line. MRO materials are particularly suited for the integrated supply concept but other situations where a large variety of products are purchased over a period of time from various product lines are also good candidates.

JIT-II. JIT-II works well when large numbers and/or quantities of products are, or could be, purchased from one supplier, particularly when frequent orders are necessary as for production materials or parts that are ordered daily from a material requirements planning (MRP) system.

Supplier City. This technique is mainly applicable to very large manufacturing plants or complexes of plants where co-location of multiple suppliers can be justified.

Distributor Cooperative. Primarily applicable to situations where a broad variety of supplies and materials are bought from distributors. Because of the increased access to lines and inventory that this technique provides, it can be particularly useful where a using location is remote from concentrations of suppliers. In such situations using a distributor who is a member of a cooperative can simultaneously increase access to material, reduce number of suppliers, and bring the point of contact with the source of supply closer geographically than would be possible with a variety of individual distributors.

Lead Supplier or Supplier Outsourcing. This technique can be used for any item where the buying company no longer wants to do the buying internally. However, it is particularly applicable to items which are not critical to the buyer's operation, bought only occasionally, in small quantities, and which have great variety. In other words, items where the risks of giving up some control of the buying process are relatively low.

V. How to Apply Supplier Reduction Techniques. We will first discuss the problem of how to organize for supplier reduction and how to determine where in a supply chain these techniques should be applied. Then we will generally discuss application of the techniques.

Organizing for Supplier Reduction. To assure success, a supplier reduction initiative must be organized as a team effort. All organizations that will be affected by reducing suppliers must be included on the team. Typically this could initially include the following functions: purchasing, operations, material planning, manufacturing, marketing, and accounting. Depending on the nature of the business, engineering, new product development, and other functions may need to be included in addition to, or in place of, some of those listed. After it has been determined who the suppliers are going to be, supplier representation must also be included to assure successful implementation of the particular supplier reduction technique or technique(s) selected. To assure common knowledge and understanding of the supply chain under study it is helpful to map out the chain and all of its parts on a large sheet of paper on the wall of the team meeting room. The various links and other information can be attached using post-it notes.

Where to Apply Supplier Reduction Techniques. Where to apply these techniques or other supply chain optimization techniques can be determined by studying the supply chains in which you want to consider reducing the number of suppliers involved. This process should be started by having the team draw a map of the supply chain showing all links or members, how they are connected, and what products or services flow from each link to the next link. Also include information on what each link or member does, when and generally how they do it, process cycle times involved, and some indication of the links' interdependencies and effects on each other. Knowledge of ordering, material control, payment, and other systems used to operate and control activities in the chain should be utilized to get this information. Do not overlook your internal costs of labor, equipment, storage space and other costs in handling and managing material.

You also need the following information about your supply chain: where and how much money, material or services, and information, exist in the form of inventories, payment streams, product flows, and work in process. The importance of all this knowledge cannot be overemphasized. Without these data you will not know what, why, and how activities happen in the supply chain and will not be able to effectively improve its performance. Be sure to add this data to your supply chain map.

Equipped with knowledge of the supply chain that you wish to improve, seven questions should be asked in reference to the supply chain:

  1. Where is the money?
  2. Where is the material?
  3. Where is the time?
  4. Where is the information?
  5. What is important to us? (the buying organization)
  6. What is important to our suppliers?
  7. What is important to our customers?

Answers to these questions will give you the amounts, timing, and locations of cash flows, location and ownership of inventories, costs of items and services, cycle times for procurement, processing, and delivery cycles, sources of information and control in the operation of the supply chain, and knowledge of what is critical to each member of the chain in the supplier, buyer, and customer relationships. These details should be added to the map of the supply chain. It is also important to identify what metrics, or measures, you want to use to evaluate the performance of the supply chain and any future improvements achieved in its operation. Measures can often be determined from looking at the items that are most important to you, the buying organization.

Application of Supplier Reduction Techniques. To begin the process of supplier reduction, the supplier reduction team should first, by using the map of the chain and the information that has been collected, determine the supply situations which have the largest number of suppliers and/or the largest dollar or volume flows of purchases. Another cut of the data should be made to identify those situations that have relatively high internal costs to operate in their present manner. The situations identified from these analyses are those that usually have the greatest potential to save cost by reducing the number of suppliers.

Next, the team should determine the existing sources and methods of supply for these high-volume or high-cost supply situations. The team then can determine candidate areas for supplier reduction by reviewing the application characteristics for each supplier reduction technique in section IV. above and matching them with the high-potential situations. The result of this process will be a list of high-potential supplier reduction candidate situations and a rough-cut idea of which supplier reduction technique(s) should be further considered for each situation.

At this point it is often beneficial to discuss several of the potential situations with prospective suppliers who could become involved in the final solution. Suppliers are usually very agreeable to do this because they perceive it gives them an advantage in the final supplier selection consideration.

Determining Target Situations for Improvement. To further analyze the potential improvement situations some estimates need to be made of the expected contribution of cost savings or other benefits from implementation of supplier reductions in the high-potential situations. Also, rate each situation with regard to ease of implementation. Projects can then be evaluated on the basis of ease of implementation and potential cost reductions that would result from their implementation. The projects can be identified into one of four categories: (A) high benefit, relatively easy to implement, (B) high benefit, difficult to implement, (C) low benefit, relatively easy to implement, (D) low benefit, difficult to implement. If you have few potential projects you will not use all four categories. If you have any projects in category (A) (high benefit, relatively easy to implement), these should be targeted first. If you do not have any category (A) projects but have some in category (B) (low benefit, relatively easy to implement), these would be a good choice particularly if you have not previously done much work to improve your supply chain performance and are still trying to convince some of your management team of the benefits of doing so.

Implementation and Evaluation. After selecting a target project, goals need to be identified for the improvements expected from reducing suppliers in the target situation. Use the measures identified in the "Where to Apply..." phase of the process discussed above. The goals must be measurable, they must be credible, they must be realistically attainable, and your entire team must agree to them. Also determine how and when the actual results will be compared against the goals. Use of benchmarks and best practices information if available and applicable to your situation can be helpful in setting realistic goals.

Plan the implementation carefully, identifying what each team member and their organization needs to do and when they need to do it to make the implementation successful. Following implementation, measure performance against the goals that have been set, evaluate the results as a team and revise the operation as necessary to optimize the performance of your supplier reduction plan.

Periodically revisit the entire process of reviewing your supply chains and reducing suppliers to assure that you continue to have the best supplier configuration in place for each supply situation.

REFERENCES

Dixon, Lance, "JIT-II: Creating the Ultimate Customer/Supplier Partnership" 82nd Annual International Purchasing Conference Proceedings, Tempe, AZ: National Association of Purchasing Management, 1997.

Ellram, Lisa M., "The 'What' of Supply Chain Management." NAPMInsights March 1994, 26-27.

Handfield, Robert B., "The Role of Materials Management in Developing Time-Based Competition." International Journal of Purchasing and Materials Management, Winter 1993, 2-10.

Monczka, Robert M., Robert J. Trent, and Robert B. Handfield, Purchasing and Supply Chain Management. Cincinnati, OH: South-Western College Publishing, 1998.


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