The total cost of procurement model will eliminate a lot of hidden costs and make your materials management process much more productive.
March 14, 2012
by RICHARD KUNST
There’s more to purchasing MRO and production items than getting the lowest price. Using the total cost of procurement (TCOP) model will help you rethink sourcing and materials management to achieve improved productivity and add to the bottom line.
When sourcing and developing long-term supplier relationships for regularly consumed products, a TCOP checklist identifies which customized services and guarantees to request in exchange for long-term commitments while guiding a materials-management team’s re-thinking and re-structuring of the materials, paper and information flow.
There are two main categories of procurement costs when a firm buys items that are not instantly consumed: buying and holding, which subdivide into buying costs (price, shopping time, paperwork, expediting, mistakes, internal handling to final consumption) and holding costs (storage space, financing of inventory, control, shrinkage, taxes, insurance).
This checklist suggests six separate costs that may be incurred to get physical goods to their final storage-usage point:
• Price, the only instantly measurable element.
• Negotiating time to get a good price.
• There’s paperwork for every purchase.
• Expediting if goods arrive at the wrong time, place or specs are wrong.
• Fixing the mistakes, including downtime costs of other deprived departments.
• Internal handling and paperwork costs when goods are delivered to a general receiving area instead of the final consumption storage point.
Once goods get to the storage destination, buying costs stop and holding costs start. Inventory ties up space and capital. It must be watched, counted and moved, so there are housekeeping and control costs. If while waiting to be used, items are damaged, permanently borrowed or become obsolete, the investment is written off as shrinkage. And finally, the overall, average investment in inventory must be insured and taxed.
All of these elements can be lowered, if not eliminated. Here’s how:
1. Best price. Offer all of your volume on a class of goods to one supplier, and request prices for differing lengths of commitment. Predictable volume allows the supplier to plan more efficiently to give you volume and cooperative-economics discounts.
2. Shopping time. It will drop to nearly zero if you hook up with one type of supplier. Wal-Mart requests suppliers eliminate outside salespeople and pass the commission on in lower prices. Presumably they would be willing to pay for the cost of a sales representative on an as-needed basis.
3. Paperwork. Eliminating duplicate suppliers will cut down on the paper, but you can get rid of more using an electronic data interchange (EDI) order and billing system.
4. Expediting. Pick the best service-providing supplier and request perfect on-time and accurate shipments in exchange for the marriage commitment. If the supplier does occasionally slip, agree on appropriate penalty fees to offset the internal costs.
5. Mistakes. See 4.
6. Internal handling costs. Eliminate them with direct-to-consumption-point delivery. If this requires the supplier to make more and smaller deliveries, delivery costs will escalate and the price must be raised. Together find the optimal order size to balance the two factors.
7. All holding costs. They’ll approach zero if a supplier delivers goods just-in-time, and there are many documented cases for this with manufacturing components.
Just-in-time should work for MRO items. Because the dollar amounts and space requirements are usually small, holding costs are not that significant. More important are buying costs and the supplier’s transactional and delivery costs. A long-term, win-win deal means covering the supplier’s delivery costs, which will offset the holding-cost savings. If MRO inventory is turning over three times a year, work with suppliers to get 12 turns, but don’t expect to get magnitudes of 20 to 100 turns.
Look for three dimensions of productivity within any new purchasing relationship:
• Efficiency. Do the same activities with more automation and less waste.
• Effectiveness. Look for ways to add additional value. Computerized inventory control systems have made reordering more time-efficient and effective. They lower investment in inventory while boosting fill-rates and allow different departments and divisions to source needs already in-house instead of buying duplicate items.
• Transformational or structural productivity. This occurs when the underlying systems that organize and coordinate people and materials are redesigned to yield higher orders of economics.
Business Week magazine noted an auto company now issues cheques for goods at the receiving dock, allowing many people in payables to be redeployed and adding a fast-pay discount from the suppliers.
TCOP is also a great tool for evaluating your suppliers. It captures subjective results related to quality, delivery, service and cost and then quantifies them for every $1,000 of annual spend. It also provides a working agenda for suppliers on the path to improvement.
If you use TCOP to lower price and zero-out most of the other costs, a structural transformation should occur. All of the activity areas touched could be downsized freeing up people’s time to pursue higher-level tasks.
Progressive firms are looking for bottom-up ideas and initiatives to achieve improved productivity. TCOP guides the re-thinking of supplier agreements and the entire material management process.
Richard Kunst is president and CEO of Kunst Solutions Corp., which publishes the “Lean Thoughts” e-newsletter.
This articles appears in the January/February 2012 issue of PLANT.