By David Bush and Melissa Beuc
- Actual demand for our product is greater (or less) than forecasted?
- My facilities have different quality standards for the same product?
- I need to select a "green," "low-cost country" or "diversity" supplier?
- My preferred suppliers have capacity or lead-time issues?
- I have only 10 days to decide the best award for five locations from 10 suppliers, 20 line items and hundreds of bids?
A successful sourcing project does not end with an auction; it ends when the awarded supplier delivers the correct product at the right time, place and cost. Implementation delivers the savings. Yet, at many companies, the "what-ifs" get in the way of realizing significant savings and product quality improvements. While an average sourcing project may take six to eight weeks to prepare and execute, the award decision can often take an additional six to eight weeks, not including new supplier verification. The additional time invested in award analysis can critically affect a company, especially if the company can obtain cost savings in two weeks rather than two months. In one example we know of, a company estimated that it cost them $1.6 million per month for an unimplemented sourcing project.
So why is it so difficult to award contracts when the savings potential is so obvious? Another company ran a $24 million auction for printed circuit boards. The sourcing team ecstatically presented $9.6 million in identified savings (an overall savings of 40 percent, with 70 percent in one lot alone). However, after six months, the actual savings delivered was $0. Why? Too many what-ifs got in the way. The joint sourcing and stakeholder team could not agree on the correct award scenarios, therefore, no decision was made.
Price factors are the easiest to analyze and compare. A sourcing analyst can calculate totals and summarize and rank suppliers for easy comparisons. But it is the other factors that prolong the decision-making process and often override the price factors. The key to a speedy award decision and implementation is managing the "what-if" factors.
The Six "What-if" Factors
There are six basic "what-if" factors, or risks, that affect award decisions and implementations. Some sourcing projects are infused with all factors, others just a few. Regardless, if not effectively managed, they can dramatically lengthen (or stall) the entire award decision and implementation process.
- Price issues: These issues are typically the most obvious and easy to manage since they are quantitative. They include any cost associated with the total product value such as product, freight, packaging costs, rebates, discounts and payment terms.
- Quality issues: Risks associated with quality are a bit more difficult to manage because some of them are assumed and not clearly articulated. Where it becomes tricky is when different stakeholder groups have different quality assumptions for the same item, such as with the printed circuit board bid.
- Capacity and lead-time issues: It is critical that companies have capacity assurance so they can meet the demand of their customers. Juggling supplier capacity issues can be very time consuming, especially when product forecasts can swing dramatically up or down.
- Regulatory issues: There are regulations such as accounting (Sarbanes Oxley), distribution and product ingredient quality (lead paint, melamine), and product sources that can affect decision making and must be managed.
- Political issues: Though global politics have some impact, it is the internal corporate politics that carry the most weight in all sourcing decisions. Examples of these issues are sensitivities to preferred vendors (due to partnerships), diversity and green vendors, in-sourcing and internal competition between business units.
- Supplier strategy issues: In addition to choosing a low-cost supplier, there are other supplier strategies that may need to be evaluated along with cost. These strategies include multi-source versus single-source, low-cost country, supplier consolidation and relative market strength of the supplier (monopoly).
Managing the "What-ifs"
Fortunately for today's sourcing professional, there are techniques and tools that expedite the decision-making process by addressing the "what-if" factors in a direct, quantifiable manner. This technique is decision optimization.
Decision optimization applies rigorous analytical techniques to bid results to arrive at the best possible decision out of a multitude of possible alternative scenarios. It empowers companies to select the best combination of suppliers, products and services on a simplified, repeatable and provable basis. By using a decision optimization tool, companies can layer different business factors/risks (for example, quality, capacity, rebate structures) to derive real-world award scenarios.
For example, one scenario might analyze bid results by excluding a supplier from one of five locations, build in rebate structures from other suppliers, award at least 10 percent of the business to a diversity supplier, while also ensuring there are at least three suppliers awarded the business. The results (the costs of the recommended supplier mix) are presented in a matter of minutes. This scenario can then be compared with other custom scenarios. Through these custom scenarios, companies minimize "what-if" risks by analyzing the impact of those risks for the company.
An additional benefit is that decision optimization is an inclusive, transparent process. The joint sourcing and stakeholder team can work together, (at the same time, in the same room), creating and comparing scenarios in a time-effective manner. Collaborating through the tool drives an expedited decision and reduces process time from six to eight weeks to 10 days. For example, by using decision optimization technology, a Fortune 50 company successfully reduced decision making time from 45 days to 11 days (75 percent) for a $110 million project. The results led the customer to state, "Data drove the strategy," and issue the award notification the following day.
In a report, technology research firm Aberdeen Group states, "Early adopters of advanced sourcing [decision optimization] and negotiations reported incremental savings of 12 percent on average, beyond what was obtained with basic e-RFx and auction tools alone." We recommend following the "Rule of Threes" when deciding to use decision optimization: for three key criteria – if there are multiple suppliers, multiple locations and multiple line items – use decision optimization to develop award scenarios. You will save time and money.
About the Authors: David Bush is the CEO and co-founder of Iasta, a provider of supply management technology and associated services. Melissa Beuc is senior director of product marketing with Iasta. For more information on Iasta, please go to www.iasta.com.