Turning Suppliers into Partners: Total Cost Management Through Strategic Sourcing

Learn how to expand your company's purchasing focus to include strategic alignment and information exchange with your suppliers in order to improve profit margins and gain a competitive edge.


Learn how to expand your company's purchasing focus to include strategic alignment and information exchange with your suppliers in order to improve profit margins and gain a competitive edge.

In today's global economy, original equipment manufacturers (OEMs) are under intense competitive pressure to drive top-line revenue, reduce operational costs, increase market share and accelerate innovation. They also feel pressure to push toward global outsourcing to low-cost regions of the world. This has led many to look to their suppliers and partners to maximize competitive advantage through faster time-to-market and cost reductions, as well as to seek ways to improve profits.

Those OEMs have shifted their strategic sourcing initiatives toward total cost management (TCM), making their suppliers strategic partners with the purchasing function's focus on total cost and lean supply chain strategies. Total cost management is one way for manufacturers to drive top-line revenue growth by using supplier capabilities to bring products to market faster. In addition, the strategic sourcing component of TCM reduces the largest cost item to hit a manufacturer's bottom line cost of goods sold (COGS). COGS represents expenses for commodities and direct materials paid to suppliers for the components, assemblies and subsystems that an OEM or manufacturer puts together in fabricating the finished end product. The combined revenue improvement and cost savings delivered by TCM makes it an appealing approach within the manufacturing industry today.

How TCM Works

Profits are also driven by revenue growth due to the entry of more innovative products into the market these are both price competitive and differentiated. Many of today's new products incorporate a combination of embedded systems that integrate software, electronics and mechanical packaging, and have a shorter shelf life than ever before. This adds up to even greater pressure on time-to-market, time-to-revenue and product profits across most industries. Hence, the performance of an organization is increasingly dependent on the overall internal productivity, effectiveness and efficiency with which it collaborates with its suppliers.

Adopting a TCM approach with the strategic sourcing tools that underpin it has been shown streamline the processes needed to guarantee product quality, product cost and time-to-market. TCM provides suppliers with visibility and input into an OEM's new product design and development processes as early as possible. This enables suppliers to recommend product designs, design features and optimal component configurations based on their own design, manufacturing, cost and delivery capabilities. This close cooperation has become particularly useful for the majority of OEMs who must now deal with increasingly complex product inputs.

While improved time-to-market for new products is a critical benefit behind TCM, it is important to understand the cost reduction that companies can realize by using TCM-driven supply chains. Some of the greatest opportunities for savings presented by TCM's strategic sourcing component come through reductions in COGS. COGS is a huge expense for most manufacturers, with direct material costs typically comprising 50 to 70 percent of the total spend distribution compared to only 15 to 25 percent for SG&A. The exact split varies by industry.

In a recovering market environment, COGS acts as a significant counter to increased revenues and thus continues to suppress profit margins. For instance, a major industrial and agricultural equipment manufacturer recently reported annual revenues of $15.5 billion and COGS over $10.7 billion. At the same time, a large retailer reported annual revenues of $41.1 billion and COGS of $26.6 billion. COGS at the two companies represented 69 percent and 63 percent, respectively. It is easy to see how TCM's impact on COGS can provide a boost to a company's bottom line.

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