QUESTION OF THE DAY: Is is possible to do JIT/Lean in production and still get clobbered by purchasing? Jimmy Anklesaria, a great strategic sourcing consultant and teacher, and one of The Mill Girl's book Agency clients,
"Price is just ONE element of cost and even within the price there are FIVE cost elements. Managing cost is not that difficult once a customer UNDERSTANDS the elements of total cost, identifies the key cost drivers and then develops strategies to reduce, change or eliminate those activities that CAUSE cost in the first place. Sadly, too many people in Procurement are too focused on taking price as a whole number and then beating a supplier down from the quoted price. I always believe that a percentage off a wrong number is another wrong number." The Mill Girl responded:
Patricia Moody YES!!! Back when Briggs and Stratton was piloting JIT, I went rogue, walked into Purchasing and mapped their process - plastered 3 office walls with one continuous cycle - in total the purchasing span took - are you ready? - TWO YEARS! By the time paper was cut, all the requirements had changed - expedites, which cost premiums - were the fall-back. It's an expensive way to run a business, but the only way to see the full horror is to map it on one continuous roll of paper! A Mill Girl at Blue Heron Journal
Spend Management is about cost management, the cost of goods sold line item that is deducted on the income statement from revenue to produce profits.
Cost of goods sold includes materials, labor, energy, travel, communications, marketing – all the direct and indirect costs that go into a product or service. What if a company has pushed as hard as it can on price increases or growing its markets and new product lines? Does that mean it has reached a profit plateau? Or might there be another way to approach survival in a limited growth global market?Well, one approach that’s been proven by companies such as IBM, Motorola, Hewlett-Packard, Apple, Waste Management, John Deere and others, is the powerful keystone of strategic sourcing called spend management. Spend management groups costs into manageable categories – hence the term category management used by many procurement operations – such as chemicals, plastics, steel, transportation – and breaks down all the elements that have historically affected those costs. In some instances spend management covers risk assessment and future forecasts for that category as well, but not all supply management operations look ahead to forecast future category prices. The spend analysis we’re talking about can be as simple as a spreadsheet or pie chart that lays out where the money goes. On the heels of that analysis of spending one can do audits of supplier contracts, for instance, or invoiced prices and payments. Pick one commodity to start with, sample costs and actual receipts against contracted quantities or purchase orders, and see what pops up. Chances are you will find opportunities to fix errors, or revisit quality and price agreements. But for deeper, more rigorous and repeatable spend management successes, you’re going to need software assistance because all the information for on going disciplined spend management cannot be squeezed into a massive spreadsheet. What about the other 80%?
When companies only focus on production or final assembly as their main cost reduction target, they are missing “the other 80%.” In automotive, for instance, where 80 – 90% of the spend goes to suppliers, leaving 20% for in-house assembly, it’s so clear that controlling costs and quality at the supply base is key. But how much easier is it to tackle 5S improvement and kaizen events, particularly if you are a manufacturing manager with no control over procurement, than to go after the numbers that lie in that big 80% chunk of the spend?
Good procurement operations, as the late Jerry York proved at IBM (see Lou Gerstner’s Who Said Elephants Can’t Dance?) can, however, save your company. What York did with IBM’s spend using analytics and West Point-style leadership, is different from what we use when we assess manufacturing operations. In spend management we are less concerned with mapping production flows and process observation and more concerned with finding the numbers behind the buy, and using sound analytics to show how the money is being spent. In companies that compete on global markets for precious commodities like copper or wood pulp, for instance, .it pays to have purchasing pros on staff who think like Wall Street commodity traders.
Let’s look at two Spend Analysis and Spend Management resources:
1. Spend Analysis, The Window into Strategic Sourcing, by Kirik Pandit and H. Marmanis
(J. Ross Publishing, 2008)
Authors Pandit and Marmanis, formerly with Emptoris, a Boston-based software
provider, assembled an extremely detailed guide to analytics in this book.
Readers will find the math behind the concept, as well as case studies from
the field illustrating just how spend analysis and spend management work.
Beyond supplier consolidation, the first step in strategic sourcing, the
authors provide graphics that illustrate actual spend
analysis examples.
Caution – the authors frequently use the term spend analysis to include management
actions that would typically be taken after the analytics are in, when its time to
tackle cost savings targets like 5% or 20% annually. I would call this execution
activity spend management; although they outline eight steps to complete a successful
spend analysis program, they really are talking about spend management here:
1. Set objectives
2. Lead from the top
3. Establish a focused center of excellence
4. Carefully evaluate choices (commodity schema, data enrichment)
5. Take a limited-scope phased-rollout approach
6. Know your data
7. Ensure that technology supports business
8. Align the team to support the organization
(Spend Analysis, The Window into Strategic Sourcing, Pandit and Marmanis, J. Ross
Publishing, 2008, page 47)
Read this book if you want to take costs down in a deliberate and predictable
way that goes beyond squeezing suppliers for annual cost reductions. Anybody
can take 3 – 5% out annually just by paying attention, but if you want to get the kind of
returns that IBM, Apple and Honda consistently achieve, you’ll have to focus
on the 80%, the big numbers resident in your corporate spend.
If you want to transform purchasing from a traditional paper processing operation to one that drives profitability, this book won’t give you all the answers to how to do that transformation and how to structure your organization, but it will give you a solid and detailed picture of effective spend management within strategic sourcing.
When managers at top companies like Ford, Honda, Toyota, HP, start to look at where
their money goes, they focus on areas that they know control 80 - 90% of their spend.
Spend management and spend analysis go wide and deep, way beyond the
single-digit savings so arduously sought in many manufacturing focused lean
initiatives. But to do good spend management, as Dorian Shainin hammered into
us at Rath & Strong, "you must let the data lead you." That takes solid
analytics, comparative cost numbers, some digging. Customers in automotive,
for instance, should know better than their suppliers when they design a
new vehicle, what the exact costs (the Should Costs, or Target Costs)will be
for labor, materials, rework, scrap, etc., BEFORE they release a design to
production where it's too late and too hard to achieve significant cost
savings. Spend management is not lean purchasing, it is detailed knowledge of
costs. That's why my book partner Dave Nelson and I want to see more and more of these
books that offer great approaches to the analytics. There is no other way to
achieve significant, lasting, double-digit and deliberate cost reductions.
2. The Big Squeeze, Ten Ways to Cut 10% of Your Company’s Expenses Right Now!,
Oaklea Press hardcover, iUniverse paperback 2011
And now for something entirely different… At less than 250 pages including the Appendix, this business novel is a painless and quick way to experience spend management from the perspective of a fictional beleaguered corporation, United Manufacturing, that is struggling to compete. Although The Big Squeeze is a business novel, the contributions from real experts in supply management, strategic sourcing, packaging, logistics, distribution, will help you take 5 – 20% out of your annual spend. Here’s an excerpt from The Big Squeeze that lays out the 12-step Strategic Sourcing process:
1. Analyze the spend
Determine the spend by commodity and in total – what we buy, from whom, in what
quantities, at what prices and when. This information is only partially available,
but Accounts Payable invoices and shipping receipts, as well as original contracts
and closed orders, will provide most of the information needed to reach an approximate
total of United’s combined spend for key commodities.
2. Establish cost reduction targets
This year, United’s CEO set a Year One 15 percent cost reduction target. The
year-to-year target should drop into the single digits, depending on gains achieved
for Year One.
3. Audit
The prices and quantities agreed to in contracts, particularly older ones may not be
the ones that appear on invoices and payments. A sampling of all receipts and payments
to compare against contracts will highlight discrepancies and immediate savings
opportunities.
4. Supplier Selection
United’s supply base numbers over 30,000 suppliers, many of which are used infrequently. The commodity team will review current supplier performance – quality, delivery, pricing and engineering support – sort the supply base into suppliers to retain, suppliers to cut, ad suppliers for whom the company needs more time or data for a decision. For items outsourced or contracted to a third-party provider, these suppliers will drop off United’s supply base. The commodity team needs supplier performance history relative to price, quality, and on-time delivery ad subjective partnering/alignment criteria. Key questions during the selection process are: Are they suppliers we want to continue with? Are their prices competitive with other suppliers? Do they offer potential for growth with us? For each major commodity, United will buy from no more than three to six suppliers;
5. Supplier Survey
United’s sourcing team needs to understand if the company is giving suppliers what
they need – information, technical assists, forecasts – to do the best job for the
customer. The supplier survey, conducted at least once a year by a third party, asks
suppliers to evaluate United as a key partnering customer relative to communications,
pricing requirements, etc. See Breakthrough Partnering, Patricia E. Moody, John Wiley
and Sons/omneo, 1993, for Motorola, GM/Williams and Solectron supplier surveys.
6. Site visits
As the souring team narrows United’s supply base to a smaller group of high-performing
supplier/partners, commodity managers will contact suppliers or consortia/outsourcing
specialists and begin consolidated volume discussions based on United’s commodity plan
and its ongoing requirements for pricing, technology and scheduling. For commodities
representing significant price or quality risk to United, commodity managers will visit
suppliers at least once a year. Each new supplier agreement will be preceded by a site
visit. For example, because some of United’s plastic parts are highly engineered for
United’s specifications, an engineer will visit supplier candidates, review engineering
requirements and evaluate that supplier’s technology and capacity capabilities.
7. Leverage the spend
We are consolidating along two paths: (a) by reducing United’s supply base from 30,000
to less than 1500 and (b) by reducing the number of buyers inside United who can
purchase material to one expert buyer, a commodity manager, per commodity group United
will centralize and consolidate all buying and in-house manufacturing. United has
decided to outsource most manufacturing, which increases purchasing responsibilities as
commodity managers source and place United’s basic assembly or with subcontract
manufacturers. Manufacturing will report to the CFO or the new CPO.
Commodity managers will complete a written commodity strategy for each commodity,
to include future outlook. Commodity managers on the team who reach savings goals will
be eligible for a bonus savings pool; managers that beat market prices will also be
eligible for a new market price savings pool. There is a three-to-one return on the
investment in central commodity managers; first year savings from MRO will cover the
initial outlay.
Centralizing the buy may be United’s most difficult change, but it is essential for
nearly every commodity, from manufacturing components to pencils and scratch pads.
United Manufacturing has been operating with a very decentralized approach to buying.
Every division, every product line and market segment, every production line and
shipping area, has been buying its own favorite materials. In some areas there are
signature limits on what a requisitioner can spend - $5,000 and under – but not even
that general rule was steadfastly followed. And of course, this explains how United
accumulated over 30,000 – and counting – suppliers from all over the world; every has
his favorites.
Engineering, for instance, likes to buy plastic parts from Acme Speed Molding because
Acme can deliver small quantities quickly for a premium. Production, however, buys
huge volumes of plastic components from a dozen generally cheaper, global suppliers.
Field Service buys aftermarket parts from yet another supplier to support its service
requirements. And some buyers have special relationships with local sources that they
feel a need to protect.
Other requirements data need to be collected and confirmed – Field Service, for instance – and
this will take six to eight months to roll into overall requirements.
All of United’s unconsolidated buying has quietly accumulated higher costs. The best
way to consolidate a scattered spend is to limit all buying to a central buying group
using a single data base, reporting in to the Chief Procurement Officer, under the CFO.
This is how Gene Richter structured the procurement operation during IBM’s turnaround.
Working under CFO Jerry York, Richter saved IBM $12B.
No checks will be cut for payments without commodity manager approval; this policy is supported and monitored by United’s CFO.
For commodities with no data in the purchasing central database, United will hire
two summer interns who will dig data from the Accounts Payable files (or suppliers
if necessary), to establish prices and quantities, suppliers, etc. As an interim step,
the information will be collected on Excel spreadsheets; spreadsheets will be replaced
or supplemented by spend management on-demand software (cost under $50k).
United will consolidate it s spend commodity by commodity, starting with MRO, telecom,
plastic injection molding parts, electronics, Transportation/logistics/Packaging/
Distribution and Benefits. These groups should represent about 60 percent of United’s
total purchased spend. We will expand the number of commodities to cover 80 percent or
more.
For example, all plastic injection molded parts with be planned and bought by our
commodity manager for plastics. No other purchases will be approved or paid for if
they are made outside Dave’s commodity plan. All requirements for these parts will be
reflected in the planning system, including Field Service quantities and engineering
prototypes.
8. Place the business
There are three ways United will place its commodity spend – through the normal RFP
and request for Quotes process, by outsourcing the spend to a third-party provider,
such as subcontract manufacturing, or by an internet auction. Some commodities, such
as cleaning materials, can be sourced through a one-time internet auction. Depending
on the results of the commodity research, United may contract all MRO office supplies
with an on-line distributor that meets our savings goal and offers an on-line catalog.
The second buying process United will sue for certain commodities, such as travel,
telecom and health insurance, is to engage an outside consultant to set up the review,
define needs and help with provider selection. Projected savings from working with an
outside expert will cover startup costs and cut three to six months from the startup
time. We want to use this help to free up immediate savings in these areas while we
dig into data to find more difficult savings in engineered and other production parts.
The first-month return will cover the initial setup investment, and the plan is to
ask the consultant to perform a yearly “health check” contract supplier review for
these commodities.
9. Contracts
United’s current procurement arrangements include an assortment of verbal and written
contracts,, some as many as 24 pages long. The only way United can maintain the kind
of spend management information that will meet ten to 15 percent savings goals and
establish baseline data points is by consolidating all buying deals into a United-
approved contract format. Strategic Sourcing and Legal have developed a revised United
standard contract, an on-line, three-page document that we will review with all new and
old key suppliers.
10. Verify, track and control
Audit the savings process; verify cost savings, track relocation of savings (reduce
budgets), and continue to monitor purchasing activity on new agreements. For example,
if Sourcing secures $50k savings on travel expenses, the travel budget should be
reduced by $50k to maintain the gain. If the $50k savings simply move from the travel
budget to another line item, the savings will be lost, and Commodity Management will
not be able to maintain ongoing savings in that category. It is the responsibility
of the commodity manager to confirm that negotiated savings appear on actual payment
transactions. On shared savings from the suggestion system, or possible supplier
development improvements, the CFO requires verification of savings.
11. Commodity Plan
Each commodity under control of Strategic Sourcing will be documented with key supplier
and market information in the written commodity plan. The commodity plan basics include
metrics on current suppliers, ongoing requirements and site visit notes.
United will track performance metrics for current suppliers – total dollars spent, quality and on-time deliveries, pricing issues, current and future requirements, future technology trends,
cost breakdown models where available or standard cost data or negotiated prices.
Initially, not all this information will be easily obtained, because so much of
United’s spend has been managed “off-line.” Where system data are missing, Accounts
Payable or Receiving files will furnish reasonable starting information on actual bu
United will not always award business to lowest-cost providers. For some products,
United will be looking for technology leadership from suppliers, not simply lowest price. The commodity plan will identify key technology needs and align them with supplier selection strategies.
For plastic injection molded parts, for instance, the manager will prepare a
requirements summary extended out through the next two years. The requirements summary
gives suppliers an idea of gross quantities and items needed, without attempting to
define all the specific forecasting flavors beyond lead times. Essentially, it is a
capacity reservation for the supplier. Next, he will review current contracts and
pricing, and based on market index projections, he will consolidate and put the
business out to bid. Other commodity managers, depending on their commodities, may
use an outsourcing provider/consortium or an internet auction to identify and contract
with good suppliers.
The Commodity Manager and his Engineering counterpart will be available to answer
supplier questions. We expect to receive quotes within four to six weeks of most RFQs.
He will review any unanswered questions and make a recommendation for his primary and
secondary supplier sources, in conjunction with Engineering input.
12. Set new cost reduction goals, and review new supplier performance data
This is an iterative process that requires annual review. Expand to new commodity areas. Initial savings from simply paying closer attention to buying patterns and working with good suppliers will get United ten 50 15 percent savings. Sustaining the savings year after year will take United Strategic Sourcing into the next level of maturity. To reach excellent or expert buying levels, United should be able to project and consistently achieve three, or five-percent-plus savings year to year. We believe that for United, moving from its beginner’s level to expert operations will require good information, good people and better systems, including on-demand spend management software, as well as some optimization planning for Transportation and Logistics. Copyright Patricia E. Moody 2011, all rights reserved.
Aerco and other leaders practice Spend Management
Tony Laraia, VP of Operations at Aerco, where he owns manufacturing as
well as purchasing, and former president of the Association for Manufacturing Excellence, believes that although “companies may not want to get into the commodities trading and futures market, which is complex and risky, they do need to manage how they buy metals. Take copper for instance, which peaked in the last six months at $4.50 per pound, compared to $.60. There is tremendous demand from places like China, where they are still building infrastructure, plus there is speculation within the Chinese government itself, and of course private entities, all buying up quantities of copper. So you end up with a lot of volatility. “
So how do we deal with more buyers in the game, and extreme volatility? And
what if you cannot automatically pass price increases down the supply chain to your
customer?
Laraia explains that Aerco, doesn’t buy raw copper, but they purchase
great quantities of tubing, castings, etc., several steps down the supply
chain from the mine and the smelter. The supply chain tends to mark up
prices as the materials are worked into final form. “It also increases the
pain, especially if you can’t just bump prices up. And that’s the squeeze
a lot of people get into.”
The lag effect and the amplification factor
Another issue related to the length and number of stops on a supply chain is
what Laraia calls “the lag factor.” Raw material enters the pipeline at a
certain price and flows downstream, but a price increase doesn't’get to the
end of the pipeline instantly. So when the price drops, you get the lag
effect, or people in the middle of the system have to get materials go at a
loss, flows downstream. It’s the amplification factor.
Locking in contract prices, as Southwest Airlines has learned when it offered
the lowest fares in the business, can hurt deeply when fuel prices shift.
The other option to better manage the swings is for the C-level executives to
be personally involved in major contract negotiations, especially over
issues such as locking, where proposed contracts become complex.
The New Precious Metals
Laraia watches copper, nickel, tin, bronze, brass and all associated alloys, and zinc.
When certain commodities become what he calls precious and the consumption patterns
change, some producers can look at substitutions to save money. Where some companies
may have been using stainless, for example, instead of copper, with copper prices
rising, demand for stainless went up. Mills built more capacity and that caused more
shifts in the marketplace.
Below the executive level, commodity managers must spend face-time in the field,
Laraia estimates 1/3 of their time, building relationships with their major suppliers.
Armed with good analytics, their objective becomes taking some of the volatility out
of the company’s strategic sourcing.
Negotiating other factors
At the other end of the market lie medical devices and their raw material suppliers.
We talked with Kevin Meyer, president of Specialty Silicone Fabricators in the San Luis
Obispo, California Area. At nearly 90% of their spend, silicone represents a huge
buying challenge inherent with unpredictable yields and quality requirements one would
expect in the kind of life-saving devices, shunts and pacemaker leads, for example,
that few producers succeed in. The company is bound by regulations inherent in medical
controls along with big liability issues that increase costs and the availability of
few suppliers. Strategic sourcing in this area is not without limits, but Meyer notes
that “there are some things we can do, like negotiate the levels of service… And we
spend a lot of time with suppliers. Between our supply chain and quality and
engineering groups, they are really a development partner.”
Continuing to work closely with suppliers is key to leading the market because
as Meyer notes, “Raw material suppliers are improving their processing ---but
medical device design is moving faster than raw materials.”
As president Meyer would like more predictability, more scheduling and delivery
stability. But as customers become more global and with Asian markets exploding, Meyer
admits that his company’s strategic decisions about where to locate production and raw
material suppliers, will over the next ten years or less, become even more critical.
“That’s a great challenge to have, a scary challenge,” he says.
It’s all in the timing
Let’s look at another strategic sourcing example that exemplifies the challenge of
spend management in critical commodity areas. Derek Mulligan, VP of Supply Management
at my old consulting firm Rath and Strong in Lexington, Massachusetts, was a supplier
engineer at Honda, where he worked strategic sourcing problems of all types. These
days he’s consulting to global clients on spend management and strategic sourcing
problems.
Mulligan finds himself on long airplane trips that mirror the distance so many of our
global commodities must also travel. Working with an aluminum company in the Mideast,
Mulligan discovered a case of momentary corporate anorexia that threatened both the
career of the supply chain manager, and the profitability of the operation. Confronted
with a CEO who felt that inventory levels were too high. Mulligan looked at the numbers
tracking inventories day to day and discovered that they were measuring the end of
quarter value when a single boatload a day could swing inventory dollars millions either
way. When a shipment pulled up to the dock nine minutes before the end of the quarter,
it was posted immediately to the books, and the inventory skyrocketed, at least
momentarily.
But the Mideast has risk issues that strategists want to be buffered from – piracy,
weather issues, long distance cross-desert routes, etc., and one solution was consortia,
joining with other smelters to establish a buffer against which any member could draw.
On paper the idea had merit, but Mulligan realized that sheer logistics proved it
unrealistic. Clearly the answer was not going to be even less inventory, so Mulligan
offered up two simple solutions for consideration, the first being inventory
measurement over a moving average, in addition to end of quarter financial metrics,
and evaluation of inventory in days of supply. Mulligan is hoping that by measuring
operating metrics that directly influence the smelters, he can offer another way of
measuring inventory that won’t risk on-line operations. It’s a challenge to consulting
firms who fly in and fly out, leaving behind unrealistically limiting inventory rules,
and that may not accepted among some consulting houses, but as a supply management
professional who knows the pain for basing inventory buys on flawed global forecasts,
Mulligan believes that global supply risk has to be built into the formula. “For so
long,” he says, “we have been driving inventory down – Taichi Ohno said to do it
until it’s painful, but we’re talking a global scenario, with large volumes, and huge
risks, and on a financial basis it just doesn’t make that much sense to take inventories
to zero at all costs.”
A little knowledge….
“It’s interesting because there are people out there who read enough to think they
understand supply management, but they are not thinking about the particulars, about
what we have to do. They don’t think about what’s really going on here.” He offers
a pointed critique of this type of narrow corporate consulting – “they do an assessment
with benchmarks of people, inventory, all the dry measures that have enough detail
behind them so that at 30,000 feet you can look at the footprint. But at the floor
level, these folks aren’t going to reappear when you’ve shut down operations! You’ve
got to look at realistic inventory numbers – calculate the cost of running out, shutting
down, starting up for overnight recoveries – it’s not cheap. And it gets ugly.”
Dave Nelson on consolidating the spend
Indirect materials can be an enormous source of continued savings. Dave Nelson tells
the story of Delphi’s experience with hundreds of packaging, mostly cardboard box,
suppliers. When companies proliferate non-standardized specifications for this type of
spend, the cardboard piles up on the floor, in trucks at the curb and in landfills
while it increases trucking and storage costs as well. But, says Nelson, it’s easy to
fix. “We reduced to one supplier, plus we had a method to cost out what a box should
ost. We just took our requirements and probably got as good a deal as there was out
there. You can save big money in the way a box is designed, but if your designers
overspec packaging, by making the specs thicker than they need to be, for example, you
need to reduce the complexity and standardize on fewer designs - take the weight out.
Sometimes designers will specify a box that is stronger than what the truckers really
need. It takes a bit of analysis to find the answers, but if you dig, you’ll find the
information. There’s money there!”
Kraig Webber, category team lead for Packaging at Delphi, lives daily with the ups and
downs of opportunities in this area. “We work with yearly cost reduction targets,” he
says, “and part of meeting the target is using value added/value engineering with the
packaging engineers in plants. It works.”
For example, Delphi’s wiring harnesses used paperboard in the shipping box. By going
\to heavyweight paper, the company found double digit savings. For corrugated pallets,
the buildup pads on the feet, they took out one layer in the wrap that acts as a foot
in nine places on the pallet, and saved even more. For partition assemblies Delphi is
fitting more parts in the same pack. Over-specification can be a problem here as well,
and it’s hard to identify who specifically should be watching this area. “Normally, the
packaging engineer would be responsible, but with some production shifting to Mexico,
we needed to do an analysis. We have purchasing on the team so that we can negotiate
pricing.”
Although engineering has their list of favorite suppliers, when purchasing gets
involved from day one, savings result. Webber sees continued challenges here, as
packaging engineering’s reputation as “the red headed stepchild, a necessary evil,” has
slowed progress. “It’s the last thing everyone thinks about, but if it’s not there on
time, or ergonomics become major issues, packaging can stop shipments.”
Guy Carter, President of The Carter Group, an Alabama-based placement firm, also speaks
to the value of sound packaging in spend management. When we asked Carter about the
ideal supply management executive, he listed five to eight years of strategic sourcing,
understanding how a commodity is manufactured, as well as who key sources are, costs
inherent in the product, as well as market history. “They don’t have to be engineers,”
Carter advised, “but they do have to be analytical. What we are seeing in most of my
searches for high level executives – vice president of supply chain or chief procurement
officers - is they are extremely analytical, and they understand the entire food
chain, all the way through production on a global basis. Not all industries have done
that, but those that have figured it out are competing globally. Industries that have
lagged include utilities and healthcare. We are going outside to find people for
healthcare,” he noted.
Carter echoed Nelson’s comment on packaging opportunities. “In chip manufacturing and
consumer audio, we see companies that have been working well on packaging. It’s a place
where they can save money.”
Norbert Ore, now a supply management consultant helping clients with consulting and
training in strategic sourcing and commodity buying, for sixteen years chaired the
Institute of Supply Management’s Report on Business. As an executive with Georgia
Pacific he trained and promoted good purchasing people. When asked what he thought
would make an ideal buyer in hot commodity markets, he responded, “The ideal buyer of a
commodity would probably have to spend half of their career in Engineering,
understanding the use of the commodities, their technical aspects, and this person
would probably also have an MBA.”
I’ve been thinking a lot lately about the separation between manufacturing people who
are preoccupied with Lean, and Supply Management pros who get involved in manufacturing,
supplier development, engineering, and other areas that contribute to cost. It’s not
clear to me why the chasm is so wide and deep and I’ve begun to think it can be
attributed to organizational structure and history. Could it be that purchasing
professionals come up through manufacturing, but manufacturing people have avoided
purchasing, or perhaps the two functional hierarchies report up to different C-level
managers? It may be that what we are seeing is two totally different cultures,
with different languages, different tools, different creeds and missions, different
performance measurements and reward systems, and different leaders. Perhaps that
explains part the disconnect.
Ore has, however, worked on both sides of the fence and takes a higher level
view of both these areas’ potential business impact. He says that “the ideal commodity
buyer probably started out in manufacturing, and then got involved in purchasing and
found they liked it! The worst part about purchasing is they come into it, fall in
love with it, and then they stay – and many professionals are quite often capable of
staying with that. They like what they are doing, and they trade off promotion to do
what they like. We are low in compensation in some places. They had to have found
that the negotiation process is something they enjoyed being involved with. They would
have an ability to manage conflict, and those aren’t necessarily engineering traits,
although they would probably be an engineer or someone with a technical background,
like a chemist.”
“It takes both minds,” he said reinforcing the idea that the best people have both
manufacturing and procurement interests at heart. And according to Ore, it is possible
to develop a new professional with both strengths.
“I had a large group of commodity buyers, and they tended to favor engineering or a
strong technical background. I knew I could teach them the commercial side of things.
There isn’t a mold that we make, it’s more about the skills - good commodity skills,
understanding applications on the shop floor and understanding the commodity supply
chain.”
We wanted to focus in on his experience with pulp and paper, a commodity market that
has gone global with big implications in its price and supply swings for packaging and
logistics costs. Although the industry has scaled up since it’s beginnings in the rag
paper mills of the 17th century, and new processes and chemicals are in play, it’s a
great study on how to buy during volatility shifts.
“When I was with Georgia Pacific, there were big challenges in pulp and paper then as
there are now. And here’s how I approached the commodity markets. The CEO would say,
‘Can you guarantee me that we are paying the lowest price in the marketplace of
anybody?’ And my response would be, ‘I can guarantee on the day that I made the deal,
I got the best price of anybody.’ But circumstances change – that’s one of the big
issues – you can’t just make the deal, you must be aware of changes in the marketplace,
because once you make the deal you’ve lost one of your most key advantages, the
competitive environment.”
Ore is telling us that volatility offers opportunity for those buyers who are not
locked in, but managing the ups and downs is not for the faint-hearted. That’s where
analytics and deep market knowledge come in. “You must be wired into the marketplace,”
he says. “For copper, silver, and gold, for instance, it’s easier, because these are
very liquid commodities and we can see what’s going on. But one of the key commodities
in the pulp and paper industry, for example, is caustic soda. Caustic soda is one of
the more unique commodities because during the conversion of chlorine into PVC, for
every molecule of PVC you get, there is 1.1 molecule of caustic soda. And when the
housing market is strong, basically to produce caustic soda you have to produce PVC.
The market has it’s own limitations on supply and demand – if the demand for PVC is low,
the caustic soda will be high demand.”
Ore pays close attention to indicators such as the market Index. “I think a lot of
commodity buying is done on Indexes. My objective was if I was buying off an index,
to lag the market. When it’s going down I want to lead the market, because
historically the sellers are much more aggressive as its going up, but buyers are
not as aggressive as the market is going down. Good commodity buyers work really
hard to beat the ups and downs. “
The pulp marketplace has experienced big shifts as many paper producers opted out
of owning their own forest preserves, along with cutting and milling operations,
in favor of buying pulp and chemicals from specialized producers. Pulp is now a
hot commodity fought over by big multi-national paper producers. Ore sees the market
in continual flux, “The dynamics of the pulp market are challenging, and a lot of
people have chosen to get out of it. There are environmental issues, for instance,
that affect supply. But then you have the Brazilian suppliers like Aracruze that
can produce pulp with shorter growing cycles – they’ve jumped into the market and
had the advantage of cheap fiber.”
Pulp
Environmental regulations have favored offshore producers, says Ore.
“When we were doing environmental pullbacks, they have been aggressive.
Procter and Gamble and Kimberly Clark got out of the pulp businesses – they are
huge in tissue and towel plus diaper products, which contributes to growing demand.
… A weak dollar helps also.”
Focusing in on the markets may mean that category managers concentrate on fewer
strategic buys, says Ore. “Typically in most paper companies there is a chemical buyer,
usually working four, five, six or seven key chemicals such as sulfuric acid. The
buying process to me starts with first understanding the spend - what are the key
chemicals, where are they used, how are they used, the usage history, what are the
specifications, what are the problems. Buyers frequently have had to deal with 200 or
more plant locations and every one of those locations has individual needs that could
be anything from delivery times, like no delivery trucks in the yard until 2pm, for
instance. My advice to commodity buyers is to first understand yourself and all your
own requirements before you start worrying about the marketplace.”
It’s not about watching the numbers on a screen however. Ore believes that great
commodity buyers enjoy a lot of supplier face time as well. “Secondly, to learn about
the marketplace, you have to talk a lot to the suppliers. At Georgia Pacific six
months before a contract was up, we would invite the incumbent supplier to make a
proposal for a one, two, three, or five- year extension of the contract. That gave
commodity buyers enormous new insight into the marketplace. From there we could begin
to make some judgments.”
“We would next bring in three or four other suppliers and ask each to give their
viewpoint on the market. Each supplier had sufficient time to do a presentation on the
status of the market. Whatever point of view I had developed starting with the incumbent, plus a few more, would give me five or six views – at that point I would have developed the advantage because each supplier would only have its own perspective. Getting multiple viewpoints compensates for loss of competitive edge. In a three-year contract, for example, we would be constantly talking with suppliers, trying to get as much market intelligence as we could because it’s critical for commodity buyers to understand what’s going on.”
Creativity trumps leverage…. sometimes
“Where bigger companies have price and contract leverage, I believe in using creativity.
In the steel market, for instance, one of the tougher markets, we find many buyers
with little leverage. That’s where creativity - knowing the market, the real specs –
counts.”
“There are also buying opportunities in logistics and transportation.
With of the unique nature of commodity buying, transportation is a major issue because
certain suppliers are not freight effective. Here again, solid analysis and creativity
helps clarify the buyer’s decisions in logistics providers.”
In the simmering dispute between traditional Cost Accounting advocates, lean
supporters of Lean Accounting, and commodity experts like Ore, measurement problems
continue to surface. “Cost accounting won’t always provide the right answers because
cost accounting is generally a figment of somebody’s imagination. Costs are often
derived numbers based on spreading overhead and other costs over various products -
these numbers do not accurately reflect the true costs associated with products.”
“A quick story illustrates. We were working with a company under a government
contract that required complete disclosure of their cost system. Well, I finally
decided they didn’t have a cost accounting system – this was a $30M per year furniture
supplier - when the manager said, ‘Accounting comes in on Thursdays!’”
“How do you know when to raise prices?” I asked, to which he responded, “Well, at the
end of the year, I look at how much money I made, and if I think I made enough, the
prices stay the same, if I didn’t, we raise them!”
Former ISM Chairman and supply management executive consultant Dave Nelson says 30 – 40%
of companies don’t know their true costs, although certainly Toyota and Honda come
closer to it than anybody.”
I’d like to think there is a Rosetta stone out there forming from the shifts and
bubbles stirred up by this on-going cost accounting argument, a magic tablet or
algorithm that will convert calculated costs to true costs to profitability factors.
It could be that the software providers will drive the solution. But at some point,
all the skills great procurement buyers have developed around should costs, target
costs, real costs, etc., should be as realistic and accessible and usable as
traditional cost accounting systems have become to everyone in manufacturing. The
question is, is there money in it?
In depth market knowledge from the suppliers themselves
Another Cost Accounting critic