November/December 2011, eSide Supply Management Vol. 4, No. 6
A purchasing practitioner offers his perspective on managing product cost with suppliers.
For many organizations, an improvement in cost performance through external suppliers is currently a top management agenda item. Big or small, global or local, maintaining — or, preferably, reducing — the costs for procured goods and services is a common priority for supply management professionals around the world.
It might sound obvious, but when faced with a cost improvement challenge from your business, a good place to start is to think about what you're practically being asked to do. Does the scope of the request apply to an innovative product or service whereby you more likely need to achieve an optimized cost, while simultaneously trading off against other attributes such as performance, delivery channel or customer appeal? Or, is the focus on a current product or service which is no longer deemed competitive or requires maintenance of a current selling price via cost reduction efforts (for example, to neutralize the introduction of more costly feature enhancements)?
It's worth noting that there's a discernable difference between price reduction and cost reduction. Cost reduction is typically sustainable over the long term, while price reduction is often a short-term commercial concession, which is then typically reversed later when the power balance in the buyer/supplier dynamic changes.
Managing cost with suppliers is complex and requires a lot of effort. Some elements of cost complexity include the multiple dimensions and components of cost for any given commodity, product or service (raw materials, labor, packaging, tooling, overhead structures, logistics, profit and so on). To truly understand these cost drivers or elements requires a level of transparency from suppliers. This can be achieved by joint buyer-supplier efforts or alternatively via the use of analytics and benchmarking. Even if a cost breakdown that underpins the price structure is made available, it can be very difficult to understand what the information is telling you.
In the absence of suitable analytics being already available, you will need to develop a cost model or database to provide some level of repeatable and consistent analytical capability. This can be achieved by working with colleagues from other functions such as finance and engineering. Also, consider the total cost of ownership when managing costs with suppliers. The cheapest price is not always the best value if this results in poor delivery, substandard quality or some other failure against a required parameter.
As a supply chain professional, being tasked to achieve a cost reduction target can sometimes feel like a lonely place — but don't despair! Some of the more mature industrial sectors (automotive, for instance) are very skilled in mobilizing discrete disciplines and departments — for example, marketing or engineering — into integrated product teams when tackling issues affecting product development, engineering and cost management challenges.
It might not be intuitive to take the lead away from other functional groups such as marketing or engineering, which typically lead cross-functional product teams like these. But, if the supply chain discipline takes the initiative of leading such groups, the likely outcome is an increased focus on delivering cost improvement — particularly when other noncommercial functions might lack targets (and incentives) to positively impact cost. To ensure the best chance of success, it is imperative to actively seek out all relevant stakeholders as early as possible to gain buy-in to the proposed process and approach. An executive sponsor is also useful to have on board early to help remove any major roadblocks or conflicts that might occur during the process.
As the same time as supply management is taking the lead and mobilizing a cross-functional team, we need to pay attention to an equally important fact: Engage with and involve the external supplier(s). Of course, the timing and degree of involvement will very much depend on the maturity of supplier relationships you have, the type of product or service in scope and any other strategic sourcing considerations (examples: make versus buy, market competition). Suppliers will often bring new and innovative ways of reducing cost to the table that might not have been considered previously. Explore looser specifications with suppliers to broaden the opportunity for cost reduction through innovation and generation of alternative solutions. (For example, "I have a requirement for a 500-milliliter drinking vessel'' is likely to have more cost possibilities than "I have a requirement for a 500-milliliter cup, in red, made of aluminium.'') For manufactured products in particular, the majority of suppliers' costs are incurred at their factories; therefore, it is the suppliers that can best understand how they might reduce those costs. Generally, the earlier you involve suppliers, the better the chance of successfully meeting your business goals, whether they're based on cost or otherwise.
A key consideration within strategic sourcing, and the associated subset of cost management, is understanding and making conscious decisions about how you intend to operate and behave with your suppliers. Most organizations are much more likely to be successful in the long term if they work collaboratively with suppliers on sustainable cost reduction, agree on how identified cost benefits will be shared and identify how suppliers will be rewarded with future business growth if they meet expectations.
Sometimes, the tendency is to attack price — also known as profit erosion — instead of cost with suppliers. Even if this is a conscious decision due to short-term market pressure, for example, be cognizant that if this is the strategy you decide to implement, it could well end up costing you more in the long run. For instance, suppliers might try to recover any short-term price concessions through opportunistic re-pricing by stealth in the long run.
Consider this hypothetical scenario: A supplier's response to a technical change requested by the customer could be to artificially inflate pricing. However, collaborating with suppliers on joint cost reduction programs doesn't mean that the relationship has to be "soft" or "cozy." It's completely reasonable to be demanding of suppliers and apply pressure to make the relationship work for you as a customer; however, the way in which you apply the pressure (for example, via the implementation of jointly developed cost improvement plans) is the most important consideration.
Once your stakeholders, colleagues and suppliers are all working together to reduce the cost of your purchased goods and services, the most difficult part is over, right? Wrong.
Consistent high performance in managing cost with suppliers takes a lot of resources, time and effort. Until you revise the purchase order price in the contract, or schedule agreement with the supplier to capture the result, you haven't met your stakeholders' — and probably, therefore, your end customers' — expectations.
Supplier cost management is a multifaceted, complex and often perplexing arena for supply chain professionals. However, if a few relatively simple principles are followed, you'll have a much better chance of successfully creating a competitive advantage for your company in the long term.
Dean Fell, CPSM, FCIPS, BA (Hons) is global purchasing executive — Compressors Supply Chain Unit — for Rolls-Royce plc, a world-leading provider of power systems and services for use on land, at sea and in the air. To reach this author, please send an email to firstname.lastname@example.org.
For more strategic cost management resources, visit the ISM articles database.
Take me to the eSide home page.