The traditional mindset of cost savings is dead

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Hemant_Porwal_100.jpgBy Hemant Porwal, Executive Vice President: Supply Chain and Operations, WESCO Distribution

Over time, the concept of measuring savings has evolved to creating a baseline by comparing items under the form, fit and function framework.

Top-quartile procurement teams have taken this further by adopting total cost of ownership (TCO) into their request for proposal (RFP) models, instead of pure price comparisons. A key point is that these TCO criteria measure costs can be principally influenced by procurement teams.

However, this is not enough. We need a more holistic metric which measures cost from the first mile to the last mile and, ultimately, within reach of customers in the last three feet. The metric to use is total cost to serve (TCS).

Components of a TCO analysis include incumbency advantage, payment terms, cash discounts, transition costs, shipping costs and e-commerce capabilities, such as electronic data interchange (EDI), e-catalogues and electronic funds transfer (EFT).

High-performing procurement teams are adding other components to the analysis to justify organisational value. These elements include:
- Percentage of spend on e-catalogues
- Managed spend as a percentage of total spend
- Percentage of spend with the top 50 strategic suppliers
- Organisational revenue from supplier sourced innovation
- Cost savings as a percentage of functional budget

When returns start to diminish
The most successful organisations have extracted value from their supplier bases over the last two decades by consolidating spend, eliminating tail spend and increasing managed spend through e-catalogues. However, some of these companies are reaching a point of decreasing returns as a result of repeatedly running the same playbook − for example, always issuing RFPs six months prior to the expiration of multi-year contracts.

I have been a supply management professional since 2013 and, in my current role, I now have visibility and ownership of the entire supply chain − from first mile (the supplier) to middle mile (distribution) to final mile (the customer). This role has given me a better understanding of the value chain analysis of systems and activities by Michael E. Porter, the architect of Porter's Five Forces Framework.

An end-to-end view has forced me to be critical of the TCO mindset, as it is very procurement focussed. My thought process has evolved to emphasise a more holistic metric - TCS − which measures cost from the first mile to the last mile. In my opinion, TCS is the future.

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TCO vs. TCS
Once your mindset shifts to the TCS model, you will no longer gauge the success of a RFP simply by how much you reduced the cost of widgets. An example involving a large utility company illustrates this point:

Imagine a procurement category manager negotiates a 5% lower TCO for rubber gloves used by utility foremen. The outcome is celebrated because (1) the unit price is lower, (2) the company will transition from a manual to an electronic procure-to-pay (P2P) process and (3) internal customers can add a single pair of gloves, reducing the amount of working capital invested in gloves. From a TCO standpoint, this is a big win.

Every time a foreman needs a new pair of gloves, a supervisor goes to the internal procurement portal and places an order with the gloves supplier (typically a distributor). In an ideal world, this automatically triggers a pick ticket to the supplier's distribution centre, where a glove multipack is broken and a single pair of gloves is picked, packed and shipped. Once that pair of gloves reaches the purchasing company's dock, someone checks the shipping manifest with an internally-issued purchase order (PO) and inspects the material.

These steps are critical in the three-way match process. Another associate in the warehouse places the item on a shelf (assuming it is a fully-functioning warehouse with separation of duties, meaning that the person receiving and checking goods is not responsible for bin or rack put-away). When the foreman is on-site the next day, an employee in the storeroom will pick the item as it is requested.

Keep in mind that this example does not consider costs associated with transportation and the multiple handling touches across the supplier and customer, which, typically, are five to ten times the gloves' replacement cost. From a TCS standpoint, this is a big loss.

Optimising TCS
Engaging with a supplier on the economic order quantity (EOQ) discussion, which factors in both inventory and handling costs, consolidates shipments so that deliveries are made only once a week.

This will reduce congestion on docks and inject productivity into warehouses. For example, the handling cost to receive a 10-pack of gloves is the same as for one pair of gloves, meaning that task productivity can be improved by 900%.

Cost savings can increase from 5% to 50% if a procurement manager understands the value chain and engages with both internal stakeholders and suppliers on the TCS discussion.

Procurement professionals should think hard about what they would rather present to a chief procurement officer (CPO): 5% in TCO savings or 50% in TCS savings. For CPOs who have run a traditional cost-savings playbook, now is the time to redefine supplier collaboration and leverage entire value chains. It requires a new level of engagement with internal stakeholders and a true understanding of the value chain as envisioned in Porter's 1985 book, Competitive Advantage: Creating and Sustaining Superior Performance.

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CPOs who are successful in making this transition will be primed and uniquely positioned to take on a chief operating officer (COO) role.

To help optimise a supply chain for efficiencies, consider issuing multiple pairs of gloves to the foreman, which adds productivity to the extended value chain. The future of supply chain lies in redefining the first and last mile.

WESCO

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