What Are You Buying?

Fundamentals for supply chain automation

Every department within the intelligent enterprise must understand the nature of the goods and services that it buys and consumes. This knowledge is essential to improving efficiency and quality of material inputs and reducing the overall landed cost of goods and services. Unfortunately, supply chain technology selection and implementation decisions are often made without a fundamental understanding of the products and services that will be procured using the technology. Price is not everything for certain categories of products and services! Identifying the benefits of implementations becomes critical, especially in light of recent research showing that return on investment (ROI) from supply chain technology investments is anecdotal at best.

EVOLUTION OF SUPPLY CHAIN TECHNOLOGIES

Supply chain technology evolved from managing materials to manufacturing resources across a company. Technologies that came from the manufacturing pedigree were designed to improve the utilization of capital assets (property, plant, equipment, and working and human capital resources). The focus was to synchronize the purchase and transformation of direct goods and services across the supply chain in a linear fashion. The "cost of goods sold" column generally reflected the financial effect of these technologies.

An entirely new category of supply chain technology has evolved to streamline the procurement process and reduce costs associated with administrative and support products and services. These goods and services range from maintenance, repair, and operating (MRO) supplies to travel services. The reduced selling and general administrative expenses of the company reflect the benefits from these technologies. A popular misconception arose that commodity items, maintenance supplies, and administrative services can be bought inexpensively through trade exchanges and online auctions. Although buying consortia and auctions are great for driving down the price of a commodity, the savings for this category come from other areas besides price. The following example illustrates what happens when a company focuses on price alone.

PENNY WISE, POUND FOOLISH

MRO is a unique category in that MRO items must keep the production machinery operational. Price is not everything when it comes to MRO items. A major factor to consider when evaluating supply chain technologies for this category is the overall cost to put MRO items in use.

Consider the case of MRO supplier Y who was displaced after a supply chain technology was introduced. Supplier Y placed MRO items in bins across the plant, checked daily for replenishment levels, and ensured that the bins were fully stocked. Of course, supplier Y charged 15 percent more than the supplier who received the bid using the new process enabled by the supply chain technology. But this new MRO supplier does not provide the services of stocking, monitoring, and replenishing the bins across the factory floor. Highly paid maintenance workers must now search through the supply closets to locate the MRO item. If you factor the labor hours spent in locating the MRO items into the overall cost of putting them into use, the 15 percent price reduction quickly disappears. Moreover, if the plant were idle due to the shortage of the MRO item, direct labor costs increase as well.

As the example illustrates, benefits from the supply chain area do not necessarily accrue from price reductions.

TYPICAL SPENDING PATTERNS OF AN ENTERPRISE

According to the Center for Advanced Purchasing Studies at Arizona State University, the typical corporation spends approximately 57 percent of its revenue on goods and services. These purchases fall into four broad categories: property, plant, and equipment; high-value and high-volume direct raw materials; low-value and high-volume MRO and commodity items; and finally, administrative and support services.

These categories have characteristics that dictate the type of supply chain technologies necessary to achieve operating efficiencies and ROI. The purchasing function within most companies has become strategic. Unfortunately, most companies measure purchasing in cost savings metrics that fail to uncover significant opportunities for the enterprise. As you saw in the earlier MRO example, a purchasing manager may save $1,000 on the purchase price of a particular component yet cost the company thousands of dollars to source and put the component into production.