As many already know, the indirect or nonproduction spend, also known as maintenance, repair and operating (MRO) spend, deserves the attention it has recently received in the trade press. In many organizations, MRO spend is estimated at 15 to 40 percent of sales.
[From iSource Business, September 2000]
As many already know, the indirect or nonproduction spend, also known as maintenance, repair and operating (MRO) spend, deserves the attention it has recently received in the trade press. In many organizations, MRO spend is estimated at 15 to 40 percent of sales. A North Star Consulting Group study of the Fortune 1000 found that nearly 10 percent of the organizations responding had no clear initiatives in the area of MRO spend. Of those 10 percent with a plan, however, more than 50 percent had either completed an initiative or were currently implementing one. Further evidence indicates that more and more companies are developing plans for an MRO program to save money.
Why the somewhat slow but growing commitment by organizations to improve MRO spend? In a word: savings. Projected savings were cited in the North Star study as the primary business driver, scoring 4.42 on a scale of 1 to 5, the highest of all responses. But what kind of savings should companies expect? And what will an MRO program look like in the future?
A Goal Within Reach
Purchasing and finance professionals know that even marginal reductions in goods and services costs go straight to the bottom line. Most would agree that reduced costs are easier to obtain than revenue increases.
For example, in the case of a generic manufacturing company, a 10 percent reduction in indirect goods and services costs can translate into a pretax earnings increase of 50 percent. For service organizations, where indirect spend represents a larger percentage of sales, the projected impact is greater. To put it in perspective, in order to produce the same increase in pretax earnings, sales revenue would have to jump by about 50 percent. In terms of the profit and loss statement, a $1 reduction in MRO spend can be equivalent to $5 of new sales. Consequently, many e-procurement solutions today target the MRO spend.
So how are the Fortune 1000 organizations managing this spend? According to the North Star study, national contracts, purchase cards, integrated supply, outsourcing and Internet buying are the most common methods.
This area of the study drew a particularly high volume of comments, with participants emphasizing the need to combine the methods to achieve their purchasing strategies. The following general themes emerged:
- Only 15 percent used a single method, while the others used a combination or hybrid approach.
- Purchase cards and Internet purchasing were considered as secondary or support methods.
- Approach flexibility was important, i.e., one size does not fit all.
- The method was matched with the requirement. For example, purchase cards were preferred for high-volume, low-value transactions.
In short, decision makers are tailoring MRO procurement solutions by mixing and matching. The study indicates that at this time, MRO does not lend itself to a singular approach. Today's technology will allow business executives and purchasing and supply management professionals to rationalize current methods into fewer, more powerful digital ones. Here is a closer look at each purchasing method.
The most popular method is negotiating a national contract with a preferred supplier. Almost 86 percent of respondents either use or are likely to use this most traditional method. Its advantages are well-knownleveraged volumes, ease of implementation and administration and the ability to service multiple locations. Downside risks exist but are manageable. Savvy negotiators build some sort of urgency into the agreement to keep price and service levels competitive. They watch for the new kid on the block or the new technology from the preferred supplier's competitors. And they always have a backup plan in the event that the preferred supplier fumbles somewhere along the way.
Finally, national contract negotiators realize that the most important element in the preferred-supplier method is the relationship. The benefits to both parties depend on the quality of the relationship, specifically, the upfront expectations that made the agreement possible. Negotiators are aware that stakeholders must be educated and trained in order to redirect purchases to the preferred supplier. They sell the merits of the agreement, emphasizing the benefits to both company and stakeholder. Or, if the stakeholder experiences some level of personal discomfort, they emphasize the good of the team over the good of the individual. If possible, stakeholders should be included in the selection effort; if that doesn't happen, the process should involve plenty of communication.
On the sell side, suppliers must be willing to operate outside the status quo, especially during the initial transition. They must move quickly and effectively to correct inevitable miscues, thereby building the goodwill that will serve them down the road when events beyond their control impact users.
Above all, the agreement should not be oversold by either party. The buyer cannot overstate projected spend, and the seller cannot overstate discounts and service levels. If either of these conditions occurs, the agreement is jeopardized.
For the near future, this method will continue to be used by MRO strategists. Combined with other methods, it returns customary savings and other efficiencies. Over time, effective e-procurement models integrate and aggregate data to produce sophisticated national contract deals that have real-time impact.
Often considered a supporting strategy, purchase cards are used or would be considered by more than 70 percent of study participants. Their use has become an integral part of MRO procurement. Essentially the outsourcing of an administrative process, purchase cards are a move toward greater participation by suppliers in managing MRO. A purchase card program can bypass the drudgery of high-volume, low-value transactions, allowing more focus on strategic issues.
Additionally, this method is cost-efficient. Card suppliers have recently added the detail required for sourcing and reporting efforts. When they're combined with Internet buying, a synergy is created that leads to self-serve purchasing.
Purchase cards are also important in easing concerns about moving to electronic methods, much like the ATM helped facilitate high-tech, low-touch banking.
The integrated supply method is generally defined as a supplier providing a single source for a broad range of MRO products traditionally carried by many distributors. In the marketplace, however, the definition of integrated supply can be more comprehensive, falling just short of full outsourcing. It takes the basic format of the national contract with a preferred supplier and adds services such as inventory management, reorder, inventory ownership, administration and more, but only for a predefined item or group of items. It generally does not include all MRO, as would an outsourcing agreement. This method can be found most commonly in a shop floor environment, restricted to items such as fasteners, hand tools, electrical components and bearings. It is, however, a bridge to full outsourcing. Sixty percent of respondents reported that they either have used or would use this method.
As long as suppliers create value-added options for their programs, integrated supply will prove useful. Many suppliers who don't continually upgrade their offerings will face extinction. Additionally, integrated supply allows organizations to test the waters by turning over parts of their MRO business to trusted suppliers; they get a limited view of the dynamics of outsourcing. Again, the key to this method is maintaining the relationship and managing the expectations of both parties.
Outsourcing, or business process outsourcing (BPO), while popular for IT, payroll and inventory management, is underrepresented for MRO procurement. Only 32 percent of respondents use or are likely to use outsourcing as an MRO purchasing method. Decision makers seem willing to outsource some but not all of their MRO business. The study may also indicate the existence of a competent middle class of employees, currently essential to the transaction-based purchasing occurring in many organizations. As organizations move closer toward strategic purchasing and away from transactional purchasing, they will be faced with either retraining these employees or outsourcing the more technical functions such as sourcing and supplier management.
Organizations appear to be stair-stepping into outsourcing arrangements, parceling out their MRO business as providers begin to deliver promised results. New digital technologies are the keys to enabling outsourcers to make good on promises of greater savings and efficiencies. e-commerce is just becoming developed and distributed enough to ensure outsourcing success. Over the next 24 to 36 months, outsourcing MRO will become the dominant method.
Things change at the speed of light in the e-commerce space. At the time of the North Star study, Internet buying was the least-used procurement method. Indications were that many of the surveyed organizations either were not fully e-commerce enabled or were on the sidelines. Coupled with the purchase card, Internet buying creates the electronic purchase to pay synergy that is a centerpiece of e-procurement. Employees are able to leverage technology to initiate, monitor and close the entire purchase experience unassisted. Materially reduced transaction costs are also driving MRO buying in this direction. Consequently, the Internet will provide the infrastructure for most, if not all, purchases in the future.
Putting the Pieces Together
MRO purchasing, like most of today's business endeavors, is evolving toward cooperative efforts enabled by e-technologies. Traditional methods are evolving into e-methods, which combine the best aspects of each and automate the data flow between the parties. Based on the North Star study and additional developments, the following assessments can be made:
- Organizations are slow to relinquish control of their MRO business to third parties.
- Many purchasing departments continue to be highly transactional and often favor traditional, proven methods of procurement.
- Organizations are moving toward purchase cards but still consider them part of a secondary strategy.
- Organizations are open to turning over parts of MRO but not all (integrated supplier method).
- Many companies may have access to the Internet but have not fully embraced it as a strategic purchasing tool
The Future of MRO Purchasing
- Companies will move from transactional purchasing toward strategic purchasing. Retraining, redeployment and some displacement will occur.
- Traditional methods of managing MRO will merge into two primary methods desktop (self-serve) purchasing and outsourcing.
- The least-used procurement methods of today will be the dominant methods of tomorrow.
- Accelerating technology allows the rationalization of procurement methods. Before fully developed and fully deployed Web-based technology became available, MRO spend management required several methods in order to meet the inherent diversity of indirect materials.