An old adage suggested, “You can have Quality, Low Cost or Quick Delivery, just not at the same time.” Lean and other continuous improvement practices have proven this to be generally inaccurate. Still, the challenge remains to achieve all three consistently while simultaneously dealing with increased regulatory and material costs, pass-through pricing pressure from hospitals and buying groups and global sourcing strategies. However, there are ways, even in challenging times, to reduce cost and lead times while maintaining or improving margins.
Identify and Address Cost Drivers
Whether you’re an OEM or a contract manufacturer, margin preservation is critical to your business success. To accomplish this, price reduction concessions must include equivalent cost reductions. Regulatory concerns and change control restrictions may make modifications to material—or in some cases even design for manufacturability—impractical, and so may not be a means to address this. Therefore, it is important to identify all cost drivers, not just the material-related ones. Two areas in which improvements can lead to non-material based savings are overhead leverage through improved capacity utilization and collaboration.
Leverage Overhead through Improved Capacity Utilization
One of the greatest challenges for a contract manufacturer is smoothing demand to avoid over commitment, or allowing equipment or staff to be idle through the typical demand curve, which can be a sawtooth cycle of demand that exceeds capacity, or not enough work. In addition to the impact that this has on overhead leverage and capacity utilization, it leads to erratic lead times and impacts margins with overtime and expediting. An important consideration to this end is to monitor and balance your equipment investment and staffing level to suit your business plan. Unfortunately, neither of these can be increased or decreased easily in the short term. The real challenge, then, is how to smooth demand and meet the delivery and cost requirements of the OEM while remaining competitive and profitable.
One solution that works to the benefit of both parties is to move from a purchase order-to-purchase order (PO-to-PO) strategy to a supply agreement that incorporates capacity management and projected demand in its terms. In its most basic form, the parties agree on a lower and upper capacity commitment. This commitment strategy gives the OEM the assurance of a consistent minimum or staged manufacturing schedule during periods of high demands, such as a new product release, with neither of the parties having to pay for overtime or expedited delivery. For the contract manufacturer, in addition to the smoothing of high demand, periods of low demand can be used to build semi-finished items or components for future assembly and complete some pre-agreed maximum quantity to be purchased by the OEM in the future.
Even though it includes cost to carry for the supplier, when managed well, this strategy is often a lower-cost solution then allowing equipment to sit idle and cost of expediting; it also offers significantly reduced lead time for the OEM on future orders.For this strategy to work, however, the OEM and the supplier must engage in meaningful cost-focused collaboration.