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.

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.

For example, the chief procurement officer for a leading international manufacturer of electronics products and telecommunications systems reports that material purchases represent the single most important cost item in its profit-and-loss (P&L) statement, and that a 5 percent reduction in these costs would add $1 billion to the company's bottom line.

Strategic Sourcing and Total Cost Management

Strategic sourcing, and ultimately TCM, aims to reduce COGS, not by reverse auctioning or "beating up" suppliers for lower prices, but rather by establishing systems for more effectively communicating with suppliers and working with them on issues of quality, delivery, standardization and innovation. Such collaboration is becoming essential as manufacturing industries undergo a transformation toward increased outsourcing in which suppliers take responsibility for production of major components, assemblies and entire subsystems, as well as product design and assembly. For example, a leading manufacturer of computers and peripherals recently reported that whereas it was 90 percent vertically integrated in the 1980s, today only 10 percent of its components are manufactured internally.

In the 1990s, organizations deployed lean manufacturing concepts to streamline their internal operations. The "lean" concept involves a strict employee focus to eliminate waste of all types through standardization of work processes, zero defects, flawless new product launches and secured supply sources. Product companies are now extending "lean" to the supply chain in order to achieve TCM.

This shift gives OEMs an opportunity to use innovations stemming from the background and skill sets of their suppliers. However, reaping this benefit hinges on the relationships being properly managed so that communication and data exchange occur seamlessly, through collaborative processes that allow suppliers to provide ideas and suggest product changes throughout the product lifecycle. This level of close collaboration is particularly important early in new product development when concepts are beginning to take shape and changes are made most easily and inexpensively. In fact, once a product reaches its final design, 80 percent of the product costs are locked into place, making early supplier collaboration critical to costs.

TCM Requires Cross-functional Team Collaboration

A growing number of companies have elevated purchasing to a more prominent position within the organization, often led by a C-level executive who reports to the company president or CEO, reflecting the potential impact of purchasing on a company's bottom line. Thus, titles such as Chief Procurement Officer and Procurement Director are emerging in the upper ranks of corporate organizational structures.

Beyond working more closely with suppliers, the purchasing group also must collaborate closely within its own enterprise across a variety of different disciplines including engineering, manufacturing and finance. Moreover, it often must spearhead a cross-organizational alignment and commodity councils that put the efforts of suppliers in sync with internal groups from those areas. Executive-level commitment and direction become critical when instituting such organizational realignment in order to obtain buy-in from all necessary stakeholders. But with high levels of commitment comes a high payoff, such as direct collaboration between suppliers and OEM engineers, alignment of centralized corporate purchasing with decentralized purchasing departments, company-wide visibility into metrics on supplier quality and performance, and streamlined supplier design and sourcing collaboration through standard electronic tools, among others.

Tools and Technology

Since strategic sourcing and TCM focus on understanding product cost drivers and expanding lean concepts through the supply chain, and given the functionality required to consolidate and comprehend such a wide range of product data and to enable collaboration between so many dispersed groups within the supply chain, best-in-class strategic sourcing solutions have product lifecycle management (PLM) technology as a foundation.

PLM technologies enable companies to manage all information about their products, from initial concept through to manufacturing and after-market service, within a single information environment that ties together all product-related processes, data and non-product documentation across a company's value chain of customers, employees, partners and suppliers. All elements of product data (computer-aided designs (CADs), engineering requirements, product schedules and plans, analysis results, sourcing plans, product quality management, and manufacturing inspections) are incorporated and tied to the processes and tasks undertaken by internal and external teams.

The following are the critical components of a PLM-based strategic sourcing and TCM solution:

*Supplier Information Management: Purchasing personnel need to track and update supplier profiles, while suppliers can access and update their own profiles. This enables purchasing to:
- Track supplier business units and locations
- Maintain approved supplier lists (ASLs)
- Track supplier process capabilities and certifications
- Publish supplier standards
- Maintain commodity teams and councils with buyer desks

*Supplier Development Planning: Purchasing and suppliers should have the ability to access a single environment for creating, reviewing and sharing development plans. In addition, development managers and individual production facilities should be able to report and track key supplier metrics.

*Information Security: For each product part or sub-assembly, buyers must be able to assign supplier responsibilities (i.e. design, manufacture or test). The solution should also control the levels of a bill of material (BOM) and the types of data that a supplier can view. Administrators should also have the option to configure role-based access to specific information where general rules do not apply.

*Product Quality Planning: Solutions should offer part quality plan templates with work breakdown structure for suppliers to achieve process standardization and predictability. Detailed templates should allow for plan scheduling and completion dating, with plan dashboards for viewing status and tracking issues.

*e-Sourcing and Sourcing Templates: Further standardization can be achieved when solutions include request for quote, proposal and information (RFx) templates in support of commodity, program and BOM-based sourcing, particularly if the templates allow for customer, purchasing and supplier input in addition to automated online tools.

*Cost Management and Estimation: To understand the product cost drivers in the supply chain and the various categories of costs that go into each assembly, the system should be flexible and able to capture detailed cost breakdown information for each item. Calculations and roll-ups of this information must be supported.

*Decision Support and Analysis: Sourcing analytics are needed for profitable decision-making and award justification. Solutions should provide simple reports and dashboards that dynamically roll-up line items and calculations.

*Sourcing Program Management: Once the savings opportunities are identified, the team should be able to implement a project plan to capture and drive the savings to the bottom-line faster with detailed work breakdown structures.

*Single, Unified Environment: Given the large number and varied locations of people and organizations involved when strategically sourcing, the ideal solution must provide a single information environment accessible by all stakeholders. This is the only way to ensure that the right people view the right information exactly when they need to view it in real time. Of utmost importance is the ability to execute the sourcing process in parallel with much of the upfront product design phases. Without this capability, the opportunity for supplier innovations to positively influence product design cost reductions is greatly hindered.

Strategic Sourcing and TCM in Action

Companies using strategic sourcing can expect, on average, to improve buyer productivity by 15 percent, reduce material costs by 2 to 5 percent, lower overall product costs by 5 to 10 percent, and shorten sourcing cycle times up to 50 percent. Moreover, the potential improvement in profit margins is higher using strategic sourcing versus traditional purchasing methods and approaches. Following are several examples:

A major supplier of automotive systems implemented a strategic sourcing solution with two major goals in mind: to gain a single source of product information for collaboration with each of its 120 suppliers, and to improve product quality and launch speed by enabling earlier collaboration between its engineers and suppliers during prototype development. In less than one year, the company achieved a more strategic relationship with each of its 120 key suppliers and reaped a return of two-and-one-half times the entire project cost.

Continuing the focus on automotive, an automotive OEM is implementing PLM to improve its overall cost analysis when collaborating with its massive supply base of 2,500 suppliers. The OEM is targeting productivity improvements in excess of 30 percent, which will result largely from improvements in cost analysis and cost tracking/data retention within a single information environment. Cost analysis improvements are expected in the range of 75 percent by suppliers providing more accurate quotes as the result of improved visibility into product designs.

One global consumer products manufacturer formerly relied on traditional paper documents to interact with suppliers around the world, which resulted in inefficient information sharing in the supply base, causing excessive costs, delays and pricing problems. By implementing online sourcing and improving suppler communications, the company was able to collaborate earlier with suppliers so that all product data and changes were visible in real-time to all key participants. Furthermore, the move to online quotations resulted in an estimated $200,000 of annual savings in shipping costs and created additional savings through early supplier product data collaboration, information sharing, reduced product iterations between OEM and supplier, and shorter overall time to market.

A major supplier of industrial systems used strategic sourcing to establish what it calls "global commodity management," whereby its internal buyers across specific areas share information within the team and also work more closely with approved suppliers. Using this approach, the company is on its way to achieving its goal of shortening the request for quote (RFQ) process time by 75 percent, reducing warranty costs by creating and tracking quality metrics for suppliers, strengthening relationship with key suppliers, and reducing overall cycle times through better communication with suppliers.

As noted earlier, the largest gains are achieved when communication is improved early in the new product development process, when concept designs are just being formed. By collaborating more effectively at this stage through strategic sourcing, a manufacturer of electronic controls, for example, was able to significantly reduce product launch costs by improving on-time supplier PPAP (production part approval process) from 28 to 90 percent over two years. Conservative tangible cost savings from this area of the solution alone is resulting in savings of $1.5 million annually.

Finally, a major high tech company leveraged TCM to perform "design for supply chain." By providing a single, unified environment for internal design engineers and external suppliers, the company has been able to drastically reduce communications errors in the earliest design stages. As a result, design change iterations have been drastically reduced, saving the company more than $10 million per year.

Conclusion

Strategic sourcing and total cost management provide product companies with benefits by transforming suppliers from parts-makers to partners in the product lifecycle. With purchasing expanding its focus from solely pricing to strategic alignment and information exchange, companies are realizing improved profit margins and earnings per share through cost reduction, quality improvement and rapid product innovation.

About the Author: Rohit Tangri is director, Product Management, at MatrixOne.

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