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esourcingwikilogoThis week's eSourcing Wiki-Wednesday topic is  a follow up to one from a few weeks ago on Intro to Sourcing Optimization. Now it is time to discuss the benefits of using optimization. An excerpt of the article is below, but you can also read the full article on the eSourcing Wiki by clicking here. Have something to add? The eSourcing Wiki is an open content community and you are invited to register and contribute to this resource, which benefits our whole professional community.

If you are interested in reading more or commenting about Sourcing Optimization, read today's blog post on "The Point": The Benefits of Optimization.

Benefits

One area where the marketing materials and available literature does not fall short is when it extols the many benefits and virtues of decision optimization which are achievable when the technology is sound, complete, and properly applied.

Significantly Reduced Cycle Times

There are dozens, if not hundreds of case studies, available from all of the major and minor vendors and analyst firms extolling the huge impact that e-sourcing suites have had on cycle times, typically reducing the average cycle time from 3-4+ months to 3-4 weeks. However, few of these reports focus on the cycle time savings achieved by decision optimization alone. In a complex category, decision optimization will trim weeks, and sometimes months, of analysis down to a few days. Before decision optimization technology, a buying group had to manually construct a number of award scenarios that they believed would satisfy all of the constraints and then analyze each one from a compliance and cost perspective, and repeat this process over and over until they arrived at the best solution they could find in the time available. With (true) decision optimization, once a model has been populated and fully defined, a buyer just needs to push one button … ‘solve’ … and the optimal answer is computed, often within minutes. The buyer can then tell the tool to solve “what if” scenarios without each of the strategic constraints to determine if the constraints or business rules are worth the cost and generally within a few hours a buyer can have confidence that the selected award decision is right for the organization. If confidence is lacking in the demand forecast, a few scenarios at increased or decreased demands can be run to select an award allocation that is expected to be near-optimal across multiple allocation volumes within a few more hours. Even when dealing with the most complicated category, a buyer can often settle on a near-optimal award with confidence in a day or two whereas in the past a buyer might not have identified a reasonable solution even with weeks of careful analysis.

Significant Realizable Cost Savings

Although the goal of this wiki, unlike some white papers, is not to overburden the reader with statistics, there is one statistic in particular from Aberdeen’s 2005 Report on “Success Strategies in Advanced Sourcing and Negotiations: Optimizing Total Costs and Total Value for the Next Wave of E-Sourcing Savings” that needs to be restated: “Early adopters of advanced sourcing and negotiations reported incremental savings of 12% on average, beyond what was obtained with basic e-RFx and auction tools alone.” And one statistic in particular from Aberdeen’s 2007 follow up report on “The Advanced Sourcing and Negotiation Benchmark Report: The Art and Science of the Deal” that needs to be restated: “Enterprises that are employing advanced sourcing techniques are still identifying an average savings of 11.9% per sourcing event. Furthermore, best-in-class enterprises are identifying an average savings of 13.7% per event.” Double digit savings on average, 100% realizable because the award allocation was generated based on complete cost information that also took into account all of the relevant real world constraints. Furthermore, the 2007 Aberdeen report found that organizations not employing advanced sourcing techniques, such as optimization, are no longer obtaining double digit savings on average.

Best Overall TVM Sourcing Decisions

The right buy at the right price every time. No other technology can guarantee that!

Repeatable!

Unlike e-auctions, which are only of benefit until all of the fat has been squeezed out of a supplier’s margin, and which generally only net results on direct cost components for a limited number of applications, decision optimization will net results every time as it takes into account all of the continually changing costs, demands, and constraints.

Ten Strategies for Success

In their 2005 Report on “Success Strategies in Advanced Sourcing and Negotiations: Optimizing Total Costs and Total Value for the Next Wave of E-Sourcing Savings”, Aberdeen listed eight strategies which they believed represented the best practices of leading edge companies that used advanced sourcing toolkits. This wiki goes one step further and identifies ten strategies that deliver results when deployed with a sourcing process that integrates decision optimization.

Combine the Art with the Science

Make sure the sourcing solution selected includes a true decision optimization tool that supports cost models, supply market knowledge, and all the basic constraint categories (the art) in addition to using advanced analytical technology built on solid mathematical foundations (the science).

Clear Goals

Two of the biggest barriers to success in any sourcing project, as described in the companion wiki “Strategic e-Sourcing Best Practices” are lack of focus and lack of clarity. Just like an ad-hoc on-the-side project will not be successful, neither will a project that just broadly aims to increase value or reduce spend with decision optimization technology. There is a need to fully answer the what, why, when, where, who, and how questions before a valid scenario that will yield an optimal answer can be built. For example, What needs to be strategically sourced? What is the strategy? Why? When is it needed? Where can it be found? Who supplies it? How can it be transported?

Look at the Big Picture

A sourcing project can save 10% but still be a dismal failure due to unintended consequences. For example, if the suppliers were not properly qualified and a new low cost supplier was selected that was not capable of palette transport while all of the other suppliers were, and this supplier supplied the item in question to each of the organization’s major warehouses, this would likely incur additional personnel costs at each of the warehouses and this would more than cancel out the perceived savings of the lower cost supplier. A strategic sourcing project should always be undertaken with respect to an overall supply chain plan which looks at all of the relevant issues. Such project should take into account any volatility in the market due to capacity or price and revise forecasts and cost estimates as late in the decision process as possible.

Encourage Supplier Innovation Through Flexible Bidding

A single price per unit bid does not paint a very accurate picture of a supplier’s cost of goods sold or identify any potential opportunities for cost savings. On the other hand, a tiered bid structure that incorporates fixed costs, variable costs, and discount opportunities that accurately represents the supplier’s true costs allows for the determination of a plethora of opportunities for immediate and future savings. With a single unit bid, a supplier would be likely to play it safe and provide his best price at his worst production level. With complete cost information, it is possible to determine when a production line is being fully utilized, when the best price can be obtained, and what opportunities there are for joint ventures to reduce significant cost components.

Reward Suppliers for Quality and Innovation

Every product purchased has impact costs. Poor quality components lead to decreased customer satisfaction and lower sales figures. Components with a high defect rate lead to large numbers of returns which have associated processing costs. On the other hand, high quality components decrease customer service costs and contribute to increased sales. Furthermore, innovative companies have great marketing value. It is important to take into account these qualitative factors when analyzing bids. Sometimes the most expensive product is the cheapest overall. In a bid-oriented model, be sure to reward high quality and innovative suppliers with negative impact costs. Not only is it the right thing to do, but it will lead to the right allocation in the long run.

Evaluate the Full Range of Possibilities: Unconstrained and Constrained

Do not settle for the best answer given the starting constraints. Find out how much each constraint is costing the organization and if it’s worth it with respect to the sourcing and supply chain strategies that are currently in force. If it’s not, either change the strategy or get permission to make an exception.

Engage all Relevant Stakeholders

Organizations that excel in strategic sourcing have adopted, developed, and enforced best-in-class strategic sourcing procedures across every department in the organization consistent with an overarching “destination” supply chain design. Not only can engineering and product development help to adequately define the requirements for the product that is being sourced, but they can help with the assessment of supplier offerings. Marketing can advise with respect to whether or not any suppliers are beneficial from an image or partnership standpoint. Customer service can advise of any expected support requirements or costs. Engaging all of the right parties insures that the right information is available upon which to base a decision.

Apply Analytics to the Front End of the Process

Considering that as much as 80% of the final product costs are locked in during initial product design, it is vital that the sourcing process start here and include decision optimization.

Identify Process Improvements

With the increased visibility into a supplier’s cost of goods sold and complete total cost of ownership cost models, one can use decision optimization to identify areas where process improvement could make a significant impact. For example, select a significant cost category and run decision optimization to determine what the net effect would be if costs were reduced by 3%. Consider locking in 100% capacity utilization on a production line as a means of obtaining additional discounts from a supplier. Evaluate more efficient transportation options.

Target 100% of Spend

As was stated in section 2.2, Decision optimization is applicable to any sourcing problem – not just the large or complex ones. Statements that decision optimization is only for “large problems” or “complex categories” or “strategic spend” are noting more then a myth. The effort involved, which is minimal with a well integrated sourcing suite, is always worth it.

 About eSourcingWiki

eSourcingWiki is an open content community of strategic sourcing and procurement best practices. This wiki is intended to be a dynamic document that constantly adjusts and transforms to current trends and thought leadership in supply management. IASTA welcomes global contributors to assist in the ongoing documentation and knowledge building that is essential to creating useful information for supply management professionals.

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