Supply Chain Cost Reduction

January 1, 2011

Along with Lean and ERP, Supply Chain Management (SCM) is a hot topic in today’s world of global operations management. In the last ten years, numerous enterprises have replaced their Purchasing Manager with a Supply Chain Manager. Yet, in many of these companies, little has changed in how they conduct business with their suppliers. This article will address how to achieve real value with SCM by identifying and reducing total supply chain costs.

Traditionally, cost reductions are achieved by getting suppliers to reduce their prices. To this end, we employ tactics such as competitive bidding and negotiation. But these tactics simply push the cost down the supply chain to our suppliers. And, while we may achieve a cost reduction in our product, the cost is still present somewhere in the supply chain. To achieve real supply chain cost reductions we must work with our suppliers, to reduce their costs.

For years we have dealt with our suppliers at arm’s-length. We provide them with an RFQ and, if they are the selected supplier, we award them with a purchase order. We then negotiate with them to reduce their price, which is based on their operating costs (material, labor and manufacturing overhead). But, negotiation does little to reduce a supplier’s costs – it reduces their margin.

Arms-length relationships are not conducive to sharing cost reduction opportunities, especially when negotiations are involved. Therefore, in order to open the discussion of cost reduction with our suppliers we must first develop a partnership with them; one based on truth, honesty and the mutual benefit of both parties. Partnering involves developing reliable single-source suppliers for your critical components and material. When a supplier knows that he is not going to lose the order to a lower bidder, he will be more willing to address his cost issues with you. And, once you know a supplier’s cost drivers, you can begin to address cost reductions that will benefit both parties, and ultimately lead to lower supply chain costs.

For example, you might reduce the cost of your product by reviewing the material specification with your supplier, and allow them to recommend a lower cost material which provides equal or improved performance. Or, you and your supplier might agree to use the same outside processing supplier, thus improving his utilization, and leveraging his set-up and expediting costs for small lots. Or, you might work with your suppliers to analyze low yield processes and help them to implement process improvements. You might even subsidize the cost of a new machine for a supplier which holds tighter tolerances, thus reducing his scrap cost.

The list of opportunities for supply chain cost reduction is endless once you open the dialogue with your suppliers about costs. Only by identifying and mutually attacking the cost drivers, can you realize the value of SCM and achieve total cost reductions in your supply chain.

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