Year after year price reduction programs: A fantasy world
Senior management asks purchasing executives for year after year savings. In the indirect world, this means that, if you spend $20,000,000 in 2008 and the selected program provides a 10% reduction in 2009, the price is now $18,000,000. If the contract term is three years, the “year after year” concept would require a price reduction of $5,420,000…not including any price increase index factor.
Where does this hit the wall?
Any MRO distributor or CPO who promises this must be ready to fail and/or be ready to cover it up. Year after year cannot succeed in the world of MRO and yet purchasing people will ask for it and distributors will promise it. The complexity of MRO pricing among the supply partners and the varying discount factors among categories make it impossible for accurate measurements. The only valid measurement of price performance must include unit price times quantity consumed during a given time period.
Since MRO quantities consumed are vastly different in any time period, a measurement from year to year cannot be viable. The bottom line in the real world is that “year after year” price reductions will not occur unless the suppliers are willing to sell for less than their cost of goods, i.e. lose money…not the case. When “year after year” is offered, it is a fantasy not to be realized.
Arkansas commented:
Is orice everything? What ever happened to quality, value, and service? Do those not mean anything to MRO buyers anymore? Or, do the companies just not care anymore?
Procurement guy commented:
The article's title allows you to draw all conclusions from the
get-go. If you are in a fully tactical organization where the goal
is to have year after year price reductions, then the article is
close to reality. If you are in a strategic organization where the
goal is to have a year-on-year cost reduction, then this is
something totally feasible. We're talking basis, part of what
distinguishes companies creating competitive advantage, from
laggards.
me commented:
hi pok!
Cotton commented:
Well said. A benefital MRO supply program focuses on process
support and excellent service. Product cost only one component of
the supply relationship.
Scott Dailey, C.P.M. commented:
I agree that simply 'forcing' through year over year reductions is
a farce. My employers also went for the 5% annual reduction, which
was only met once. However, there are valid measurement tools
available to accurately measure changes in the 'basket of MRO
goods' that a company uses. First, let it be known that quantities
consumed do not vary be huge amounts in a typical manufacturing
business. There are some 1-off items that are impossible to
predict, but by and large the 80/20 rule applies ... 80% of MRO
volume is driven by 20% of MRO items, and these items are
repeatable over given time frames. Focus on these items, construct
your 'basket of MRO' goods, and build an MRO price index. Measure
the changes over time, dig into the details, and work with
suppliers to pursue reasonable and fair prices over time. Today, of
course, many commodity prices are falling, which should lead to
lower prices once the prices flow through the supply chain. Happy
shopping.
