By Rob Olney, President, ETM Manufacturing.
I was once in your shoes – in procurement and sourcing roles. First, I was with Flextronics and then moved on to Staples. After a few years, I pursued a different challenge and today am president of a custom-sheet metal manufacturer near Boston, Mass.
Sitting on this side of the table, I find that not much has changed in terms of the metrics by which the profession is measured. Driving the lowest possible price from suppliers is always job #1. What I have learned is that sometimes there are good reasons why a bid may not appear to be the lowest, but may in fact be the better choice in the long run. Understanding a supplier’s costs – beyond the quoted price of the part or product – can inform a better decision overall.
In addition to material costs, elements to consider include labor, service, overhead and finally supplier profit. Digging deeper into these costs and what they mean for your pricing can eliminate ugly surprises and result in a better final outcome.
When Thinking about Materials, Think Like the Supplier
Beyond the cost of the material used, it’s helpful to understand the hidden costs behind the material component of the cost equation. You can help the supplier – and yourself – by asking yourself and your team a few questions:
•Can the design be optimized to reduce the amount of waste or scrap produced?
•What’s the cheapest – and most secure – way to package and ship the finished product?
•What percentage of inbound freight costs are mine?
•What are the trade-offs between holding raw materials and purchasing only when needed?
The Real Cost of Labor
A critical part of the quote is the cost associated with labor. Similar to material, it can be immensely valuable to understand how the supplier arrives at the labor component.
Direct labor is the labor cost assigned to make the products. Indirect labor is the cost assigned to run the business. Suppliers take different approaches to how labor costs are assigned, e.g. one company might assign engineering labor as a direct cost and another might assign engineering labor as an indirect cost. Get a good handle on how your suppliers assign these costs in their accounting system and you’re less likely to pay for more than your fair share of indirect costs.
Take workflow into consideration. The number you see is the average cost calculated for skilled and unskilled labor and hours required from each needed to get the job done. Scratch below the surface and you’ll uncover that the design drives, in large part, who will spend the most time on the job and where the costs are coming from. Will choosing a different material change some of those conditions? What changes to the product might reduce some of the time required by those with the highest landed cost? Can the supplier lower packing and transportation costs by handling it themselves?
Don’t forget that in manufacturing, energy, equipment use and maintenance, certifications and more are likely to be included in the “shop rate” as well.
Wrapping Your Head around S&GA Costs
Every business needs sales and administrative costs to keep running; however, some costs are waste and the customer bears the cost of that waste. Eliminating the waste reduces the costs and, as a result, prices can be lowered.
Sales, Marketing and Advertising Wages. As customers shorten forecasts and lot sizes, more risk is introduced to the production schedule. To mitigate the risk, new customers are necessary to ensure that all costs are covered. Steady forecasts reduce both risk and sales costs.
Inside Sales, Estimating and Quoting Wages. In general, if a customer is asking for quotes from three suppliers, each supplier can expect to receive 33% of the parts quoted. That’s a 33% efficiency rate. The cost of quoting the other 66% is passed on to the customer purchasing the 33%. Since none of the suppliers get the efficiency of full production, the cost of idle time is passed on to the customer as well.
Accounting and Finance Wages. Every business needs to order material, receive material, enter the material invoice, pay the material invoice and file the paperwork. Or do they? Internet businesses have proven that by reducing the variability, these processes can be automated.
The High Cost of Waste
Taiichi Ohno, Executive Vice President of Toyota Motors, thought that there was 95% waste in everything Toyota made. There are many drivers of waste in the supply chain, and to ensure that you pay only for the value of the product delivered you want to understand the nuances of these culprits in your cost:
Transportation. What is the supplier doing to optimize the efficient flow of materials and goods in and out of the operation? What do they recommend for your specific needs?
Inventory. Suppliers who apply the disciplines of lean manufacturing understand that inventory is simply waste. What are the suppliers doing to level flow throughout production and eliminate the need to holdinventory?
Over-production. What is the supplier doing to establish location-based improvement efforts to minimize or eliminate over production?
Downtime or wait time. There may be time when work needs to catch up with the next stage. Filling that time by creating several months of inventory ahead of demand, spreading set-up costs over a larger number of parts may seem efficient, but it may translate into costs you shouldn’t bear.
Over-processing. Tight control over doing the work that needs to be done and no more should be a clear part of how the supplier eliminates waste.
The Role of Profit in Keeping Costs Down
It may seem counter-intuitive to talk about supplier profit when we’re focused on driving low-cost sourcing. But consider this: Suppliers that don’t make enough to cover their debt will go out of business – and that may be a greater risk for you. It’s also worth considering that with profits come better wages and benefits for employees, translating into engaged workers who make better products and take the extra step to take care of you.
Resolved in 2016: Understand the Impact of Supplier Costs on You
With the new year coming on fast, it’s a good time to make those resolutions about how you can do more to ensure that your organization gets the best possible products at the best possible price.
When you go out to bid fully informed on material, labor and administrative costs, you gain critical advantage when it comes to choosing the right supplier.