Improving Supply Chain Performance – Reducing Purchasing Costs Through Better Planning Disciplines

Whether a business is a manufacturing and distribution company or it is a dentist’s office, these businesses all have common supply chain problems associated with their purchasing processes. These familiar problems deal with controlling costs, minimizing inventories and the associated cash costs, plus managing changes in products so that they minimize obsolescence exposure and costs.

As a case in point, I met a family in an airport that owned a family business. Recently, they had outsourced all of their production and their involvement now was more focused on managing client relationships as well as coordinating the availability of their proprietary packaging for their new product supplier. They expressed to me that they were struggling with controlling packaging costs and that each quote was typically higher than the last. When asked how they worked with this supplier, they responded that they had worked with this same supplier for years and issued purchase orders that covered just a few months of demand. Also, even though they had longer term commitments and reasonably-established production rates with their product supplier, they did not share this future demand information with this packaging supplier. After sharing this information with me, they asked my opinion on where they could improve.

I made the following suggestions, and these are applicable to almost any purchasing environment:

  1. Create and manage at least a one-year-rolling forecast of the business by product line and update this forecast at least several times per month.
  2. As appropriate, also include breakdowns of these forecasts so that it creates demand visibility for key purchased commodities or parts from these suppliers and share this information with them.
  3. When working with the supplier set up the following arrangements.
    • Enter into longer-term blanket order relationships, such as six months or one year, that will establish a price baseline on items they sell.
    • Utilize the forecasts to provide the supplier with visibility on the planned demand as well as indications of shifts in demand or volume changes as well as indications for product design changes that will impact the product they provide to your business.
  4. Structure the purchasing agreement so that your business can heavily influence or control price changes.
    • Where possible, freeze the prices for the duration of the agreement.
    • Factor in inventory carrying costs as well as freight into all negotiations and use this as another means of helping your price position.
    • If the supplier’s costs, and resulting pricing, are heavily dependent on commodity markets, then establish baselines or a commodity price standard for the agreement and then stipulate that increases, as well as decreases, will be tied to this commodity price benchmark, which in this case was corrugated paper of certain pound weights.
    • Agree on the frequency in which both of your businesses will review price increases together, such as quarterly, due to the commodity price changes.
    • Insure all other non-commodity costs in their prices are frozen during the time period of the agreement so only the commodity-affected costs are considered in price changes.
    • Establish your own in-house capabilities to review the same commodity indexes that these suppliers watch so you are able to take advantage of opportunities or minimize the consequences of pricing changes in these markets.
    • Proactively initiate mitigating actions that include purchasing futures or providing purchase orders to purchase a quantity of raw materials to lock in these costs for a time for your business and the supplier.
  5. Work with the supplier on joint Value Engineering programs where both businesses will commit to work on cost reduction efforts where the savings are shared.
    • This arrangement will insure that the supplier will help reduce costs, and associated pricing, where normally it would be against their self-interests to do so.

Many businesses, such as the one described above, have the majority of their costs managed through their purchasing department so it is strategically important to improve the processes and disciplines in this area of supply chain management. Creating longer-term planning disciplines will pay large dividends by both controlling purchasing costs as well as insuring that the company will have the purchased items it needs when it needs them and not before. In addition, creating innovative negotiating terms and structures, such as the ones described above, will allow the business to have much more influence over the purchasing process as well as improve their ability to successfully negotiate lower prices as well as mitigate or minimize impending price increases.

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Posted in Blog Post, Growing Businesses, Mergers and Acquisitions, Restructuring Businesses and Struggling Businesses

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