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Webinar Notes: Total Cost Visibility: The Key to Strategic Sourcing Success
This week’s featured event was presented by Directworks on total cost visibility. Particularly in direct materials procurement, achieving total cost visibility requires data on components as well as the supply chain that moves them. This event is available on demand, and can be viewed here. There is also a whitepaper on this topic available for download.
The event started with an overview of the five components of total cost, as defined by Directworks, focusing on best practices in each:
- Component costs: It is imperative that buyers get visibility into cost drivers and compare those across qualified suppliers and against ‘should cost’ projections. Ask suppliers for visibility into their profit margin (admittedly some sweet-talking may be required) and clearly spell out index-driven cost components.
- Transit costs: Know your incoterms, and consider the risk and cost implications of the handoff point. Include an analysis of the savings associated with sourcing where you manufacture to decrease logistics expenses. Conduct risk and scenario planning for each major port or route in advance of an issue. Investing the time and effort to plan out back-up plans is much cheaper than looking for alternatives after a disruption has occurred.
- Finance costs: Think about both payment terms and lead times, particularly in how they affect inventory costs. Make sure finance is involved early and has all of the information they need to calculate the financial coasts associated with each award scenario. Misunderstanding the financial side of a contract can easily change the right supplier into the wrong supplier.
- Compliance costs: Companies are highly dependant upon suppliers meeting regulatory requirements and codes of conduct. This may include CSR and diversity initiatives as well as insurance and licensing requirements. As with component costs, compare compliance costs across suppliers, taking into account the costs associated with any additional reporting, e.g.
- Poor quality costs: When suppliers or their parts fail to meet your specified standards, there are number of forms the costs may take. Defects are an easy to see cost, but poor quality also includes the costs associated with late delivery and lost revenue due to lost sales or reputational issues.
If it were easy to collect all of this information, all purchasing decisions would be relatively simple cost optimization scenarios. But this is not the case: the necessary data comes from a number of places including suppliers, finance (inventory), transportation systems, and should-cost models. Collecting it and ensuring its accuracy requires a coordinated effort from a cross-functional team.
Be realistic and take a phased, prioritized approach. Start with the costs that are largest (probably component and transit costs) and then work your way into the other costs. Keep in mind that in order to get suppliers to provide all of the data you are looking for (hopefully directly into a sourcing solution to automate the optimization and award scenario comparison process) you have to be willing to provide them with something of equal value. They are able to benefit from detailed feedback about their labor or tooling costs compared to their competitors. Taking this kind of approach should be accommodated in the project plan with sufficient time, assuming multiple rounds of bidding and negotiation.
This is a really interesting post and wouldn't it be great if we all knew the make-up of the suppliers costs. Recently I have a conversation with a company wanted to source raw material and looking for a different method to spot buying. The solution was to look at a longer contract and index linking. The obvious questions came up on what index and what percentage of the goods relate to this index. The simple answer to start with is always the best. Ask the suppliers for their idea on the index as a starter for 10 and when you implement the contract don't look at absolute values but look at trends. Once you get this working then next year you can increase the accuracy with a more detailed breakdown.