Buyers: Keep it simple when tracking savings
Staff -- Purchasing, 1/15/2004 2:00:00 AM
MRO buyers can have a big impact on their companies' bottom lines—if they measure and document savings resulting from suppliers' value added services.
Most purchasing operations—and MRO suppliers—routinely track such metrics as price, inventory levels and process improvements. But many suppliers also provide services that can help significantly reduce costs for purchasing. Identifying and monitoring these savings, however, isn't always easy.
Tim Underhill, president, Underhill & Associates, works with purchasing operations and with suppliers to develop strategies to better manage buying costs. He frequently leads workshops for the MRO Buyer Group of the Institute for Supply Management and was a speaker at its 6th Annual Conference held recently in New Orleans.
Underhill's advice to buyers interested in measuring savings: Keep it simple.
Collaborative effort
Many suppliers offer customers such services as summary billing and vendor managed inventory (VMI) that help reduce costs associated with performing certain tasks. With VMI, suppliers take responsibility for ordering, receiving and stocking. These activities help purchasing to reduce the time it takes to manage the buying process; these savings are considered by many to be "soft" because they don't directly affect the bottom line. For the savings to have more meaning for the customer, Underhill says that the costs need to be quantified and measured.
Quantifying and measuring costs should be a collaborative effort among purchasing, its end use customers and suppliers, he says. "Together they can determine whether the supplier is offering a true value-added opportunity."
Underhill recalls working with the purchasing operation of a company trying to reduce energy costs. "A pipe, valve and fitting supplier can have a huge impact on a customer's energy costs," he says. "This is particularly true if a company uses steam in its processes. If there is a steam leak, a company may incur costs due to lost production. The question is: Can a supplier actually do something to reduce the leaks? If they can, then they have to decide how to measure that so the customer can evaluate costs versus benefits. This is critical. What's often missing is purchasing generally doesn't know what the reductions are worth. They don't know if it's worth an extra $5 or $500. They don't know if they should be paying the supplier a premium when purchasing the product or service."
To figure this out, buyers have to develop a methodology to measure, in this example, the supplier's success at reducing the leaks, and how to relate that to cost. There are several ways to do this: They can measure the number of leaks. They can measure the size or average size of the leaks and therefore the volume of pressure likely to be lost and the cost of energy needed to ramp up a compressor to close off leaks. Once purchasing has identified these measures, buyers need to ensure that the metrics are accepted by end use customers. The key, Underhill says, is getting the right people involved. Finance and accounting managers can be valuable resources. With their expertise, purchasing can quickly cut through the back and forth of what's real.
Where to start
Because of the dollars involved and the relationships they've established, many buyers begin with suppliers of direct materials. Purchasing operations at manufacturers of physical goods such as automobiles will unearth many opportunities to work with suppliers to reduce costs. At the same time, buyers at process companies have more opportunities to reduce costs associated with purchasing MRO items.
Underhill suggests MRO buyers begin by looking at the operating budget of the maintenance department, that is, downtime, amount of rejected product, etc. MRO items affect many of a company's costs: maintenance, production, energy. When purchasing has identified a problem area that concerns maintenance or operations, they can bring in suppliers to see how they can help. Suppliers can discuss services they consider value added, and determine impact to the bottom line and risks that need to be controlled.
At this point, purchasing need approach only suppliers with which buyers have alliances or partnership type relationships. In most cases, this will be a small number of suppliers. During the supplier selection process, purchasing should look to suppliers based on their willingness to provide value added services that will help reduce total cost as well as manage or minimize risk in case problems occur with product/service performance.
Underhill finds that some suppliers who say they measure cost savings for purchasing track such metrics as the difference in price resulting from product substitution. Others measure savings resulting from inventory reductions and process efficiencies. "Very few suppliers do a good job of measuring value added from, say, improvements in energy efficiency, he says. One he notes is SKF, a manufacturer of power transmission products that has developed a program that demonstrates for its customers ways it helps to reduce costs. (see sidebar.)
Performance measures
Once buyers have identified and tracked savings, they can use the measure to monitor supplier performance. One supplier may have a lower price and not provide as much value as another supplier that has a higher price but adds more value. "If you can measure that value you can make a more sound financial decision based on true dollar impact to the company's bottom line," Underhill says.
Using events a supplier has proposed, is performing or has accomplished, buyers can determine costs to do business with the supplier. "That's what I often refer to as total cost of ownership," he says. "Borrowing an idea developed by a division of Motorola—where purchasing created a supplier performance index that measured poor performance based on costs incurred because a supplier is not performing up to speed—the Motorola buyers were able to project probable cost of doing business with the supplier based on price plus poor performance costs.
By using this model and routinely measuring suppliers, buyers can project total costs based on poor performance, value added and price. Purchasing can tie these together and make a good projection as to what it's likely to cost to buy from one supplier compared to another."
The measure can also be used to track performance. Sometimes the customer asks the supplier to do X, Y and Z, but they are not letting them do X, Y, and Z. Generally, it's because purchasing asks the supplier to perform the tasks and others in the plant don't cooperate. This is part of the reason the supplier cannot add very much value on their own; they have to do it in conjunction with the customer's personnel.
If the customer lives up to its end of the bargain and the supplier is not, it could be simply because there's a learning curve involved. Other times the supplier may not be devoting the right resources to the job.
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