Many companies manage supply and supplier relations using a transactional system. Purchases are managed as if each one is an individual transaction, and they depend upon RFQs based on pricing to pick the winner. There may be some purchases, such as with the Department of Defense, where this is required; however, the model is not sustainable over time, especially if annual price reductions are driven purely by supplier margin reduction. For cost reductions and supplier relationships to be sustainable, you must address more than just the quoted price. You must attack real supply chain improvement and cost drivers at both the supplier and the OEM with the intent to reduce cost while maintaining or improving margins.
This article will present the importance of margin preservation, examples and strategies to implement a sustainable cost reduction program and ways that continuous improvement can deliver both.
The Importance of Margin and Cash
There are numerous examples of companies, from automobile manufacturers to big box retailers, that pushed programs for aggressive price reduction based on the premise that the benefit of volume would make up for thin margins. However, the end result was both unfortunate and predictable: companies that are forced to meet aggressive price reduction targets without engaging in actual cost reduction activities are destined to eventual failure.
Other companies took a different approach, actually working in partnership with their suppliers to identify drivers of cost and waste and then develop strategies to eliminate them—the first step in sustainable cost reduction. It was found that this approach delivered higher short- and long-term benefits and emphasized the difference between “price reduction” and “cost reduction.” Bottom line: profit is what encourages and enables growth and investment in the innovation required for sustainable cost reduction. This is true for both the OEM and the supplier.
For outsourced supply, the first step for the OEM is to identify what they are outsourcing as well as the core competencies required of the supplier for the best results in quality, delivery and cost. This was the topic of the November BONEZONE article, “Outsource Innovation by Tapping into Supplier Expertise.” In summary, the purchased parts must align with the supplier’s relevant expertise. The specific expertise, or competency, needs to be identified early in the RFQ process and subsequently verified, preferably by visiting the supplier’s facility. However, this step alone will not achieve the lowest possible cost, especially for new items.
In order to achieve the lowest “total cost,” the OEM must engage the supplier as early in the design process as possible to maximize innovation and collaboration for superior design that is simpler to manufacture and use, improves patient outcome and is cost effective. Typically, once the design stage is complete, opportunities for change—regardless of benefit—are limited at best, and in most cases non-existent due to the effort, cost, impact to a committed timeline and complex web of regulator restrictions.
Identifying Cost Drivers
To reap the maximum benefit, we must first develop a comprehensive understanding of what drives cost and how we can address those cost drivers. This is true for all supply strategies, whether manufacturing in-house or outsourced, including from low-cost countries. Only if these costs are eliminated or improved can the savings be sustained. Two areas that have been found to have the biggest impact are variance reduction and innovation.
Whether you are a student of SPC, Six Sigma, LEAN, etc., you know that variability is the root of all evil. The most obvious source of supply requirements variance comes from forecasted demand or lack thereof.
We all know that forecasting is imperfect at best, but especially for outsourced supply, sharing of even non-binding forecasts or use of blanket orders will give suppliers a better handle on your overall demand versus discrete orders. Each supplier is typically dealing with a significant number of customers while trying to manage finite capacity. By providing better information on the “how much” and “when,” suppliers will be in a better position to manage capacity which, in a well-run shop, will reduce both your cost and lead time. It allows them the option of acquiring materials, reserving capacity or perhaps building components or finished product in advance of delivery dates. This benefit is maximized when they can use either open orders or forecasted demand to fill slack capacity in periods of low or no demand, such as loss of another customer’s orders. At that point, the only choice may be to have employees perform non-productive work that ultimately ends up in overhead that drives up cost or erodes margins. Implementing such an initiative will require an advance agreement between the OEM and supplier to address risk and flexibility for early delivery or holding inventory by the supplier balanced with the cost of capital. Either way, it is typically better than a non-productive shop floor, and both parties should share in the associated value creation and savings.
Another advantage of having a forward view of demand and a good variance management practice is sequential machining. One example of this is running an entire family of parts sequentially by size. This allows minor tooling and programming changes between sizes rather than a series of change overs and set-ups as a result of running random, non-related products. A similar initiative is supplier consolidation by similar manufacturing requirements. An example of this is identifying all your drivers, impactors, etc. and then quoting families of items as a group rather than haphazardly sourcing the individual parts with multiple suppliers. Should this also be a supplier’s core competency, it would also be expected that they would be the low cost producer, especially if they are able to exploit that expertize across multiple customers.