Purchasing: The Status Quo Will Cost You

I am surprised by the number of supply chain and purchasing professionals that use the terms Total Cost of Ownership (TCO) and Strategic Sourcing as excuse for inaction.

Don’t misunderstand me. I believe in total cost and in business strategy. Most supply chain consulting and university programs have these concepts imbedded in them as they are valuable and important. Where I become unglued is when the intellectual espousing of these ideas prevents action. Maintaining the status quo is one of the most dangerous strategies in business today; the world is changing fast and ill-considered inaction in the face of rapid change is extremely perilous. Analysis Paralysis is another symptom of this dangerous condition.

I like to challenge statements like “We are doing this for strategic reasons”, particularly when relating to suppliers. What exactly is the strategy and what are its costs and benefits? If these cannot be explained convincingly, in simple English, there is a problem. What exactly is a supplier doing for you that they are not doing (or would not do), at your level of business, for everyone else? Are you paying for extras that others get for free?

As an example, many purchasing departments second source components where at least two manufacturers’ components are qualified for use in their product. This security of supply strategy usually includes a sharing of volumes between the manufacturers and paying a premium to one supplier through a higher cost. Let’s assume that the split or allocation ratio could vary from 50% – 50% to 100% – 0% between the qualified suppliers for one million components with a ten cent difference in price between them. A 50% – 50% scenario is not uncommon.

Sourcing Strategy Cost

The cost for security of supply gained by allocation can be viewed as an insurance premium for supply interruption risk. These premiums have been calculated and are shown in the table to the right along with savings obtained over a 50% – 50% split. In this example, the insurance premium for equal allocation is $50,000 which could be savings if 100% allocation was acceptable. Does a 50% -50% allocation provide any greater security of supply than 80% – 20% or any other ratio? If so how? Would buying half your spend from one company and the other half from the other supplier with every item cherry picked for 100% supply based on price (with periodic application performance testing) achieve the same security goals? Don’t justify your allocation choice as strategic unless you can clearly explain the cost and risk avoidance benefit.

Once you have designed your supply chain and selected your supply base using total cost principles, should you know how your materials costs compare to others? If a characterization of the materials costs in your design showed your average competitiveness compared to the market place at the 70th percentile, should you be concerned about the price of components in your design priced at the 30th percentile?

In your design, you may have considered quality, warranty, failure rates, return privileges, stocking levels, on time delivery and many more factors that apply to all of the items that you buy, so why should the prices of some items   be so out of line with your average?

Chances are that you do not know your overall competitiveness or which components are outliers. You may be comfortable with the job you have done designing your total cost solution believing this protects your company against competition in the absence of objective information. Don’t let this comfort support inaction. You need to know how competitive you are and how much you could be saving within your total cost design. Along with death and taxes, the other of life’s certainties related to high tech is that the competitive advantage attributed to technical features will eventually erode – and product costs had better be world class to ensure survival.

I have been consulting, speaking about, writing on and managing electronics companies (Boards, Executive, Managerial, Engineering and Founding) for many years and always see opportunity for improvement. Too often I see inaction when everyone knows something can be done. My companies were created to help identify appropriate actions and can direct you in the first few critical action steps. If you have thoughts you would like to share, you can make comments on this blog or, if you would like to speak with me directly, contact me via an email to ken_bradley@lytica.com and we can arrange a time to connect.

By Ken Bradley – Lytica Inc. Founder/Chairman/CTO

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