Try as we may to develop sourcing strategies for consulting clients to consider the full range of factors that lead to lowest total cost of ownership, sometimes the task becomes next to impossible. Part of the reason involves what we call “incumbent advantage, in which firms that already have a company’s business have often educated the client sufficiently that the client doesn’t believe an alternative supplier could possibly take over or earn the business. So instead of debating the merits of that statement, we thought we’d pose a few questions to any metal buying organization to help determine if incumbent suppliers are doing all they can. Let’s start with the obvious how does the supplier not only help the buying organization manage commodity volatility, but how does that supplier manage its own commodity volatility? Let’s look to service centers as an example.
The more sophisticated service centers track an extensive number of macro-economic drivers, leading indicators, inventory levels, industry-wide capacity utilization rates, producer reports, and analyst research to not only gain better insight as to the direction of pricing, but to inform their own sourcing practices with regard to hedging, inventory optimization and overall supplier risk management. These firms deploy multi-source supply strategies, having grown their own business by becoming major buyers to more than one mill. By having major allocations from multiple sources, the service center minimizes the buyer’s risk on a number of fronts (of which price comprises just one factor). When a service center has multiple strong sources of supply, that supplier can often service the infamous “one off requirements, rush orders or competitive advantage that buying organizations often seek, particularly in the job-to-job sourcing environments most US sourcing organizations find themselves.
Questions for buying organizations: How sophisticated a sourcing program does your supplier have? And what specific programs does your supplier offer you to help manage that volatility?
Next, we examine the notion of “flexibility. By flexibility, we refer to a range of factors that buying organizations often require short lead times, volume changes, product changes, and even honoring prices outside of the quote period during rising markets. Mills, of course, have very different go-to-market strategies. Some mills work very closely with service centers and quote and supply the market largely on a short-term or spot basis (e.g. they won’t quote long-term deals). Other mills will cut longer term deals and some will always charge a $.10-.20/lb premium because they leave capacity open for “emergency runs where they know they can charge (and get) a premium.
Question for buying organizations: Does your incumbent supplier have enough significant strategic supply relationships in place to meet all of your flexibility needs?
Now let’s tackle perhaps the most controversial element ascertaining whether a supplier with very low overhead automatically means lower costs for buying organizations that source from that supplier. At first blush, one might assume a low overhead must equate to lowest total cost, but we don’t think one can necessarily draw that conclusion. For example, a more sophisticated service center might have customer development teams folks that remain on the payroll of the service center but whose sole job is to identify cost reduction opportunities jointly with clients. As an example, this team might come for a site visit and spend 1-1.5 days speaking with folks on the shop floor. The team comes back and provides a 3-5 page written report with specific recommendations for cost reduction. In one case, we know a team like that identified a minor product change to reduce the incidence of some cracking resulting in hundreds of thousands of dollars of annual cost savings.
Question for buying organizations: Does your incumbent supplier suggest to you specific cost reduction strategies on a regular basis?
Finally, we want to move into an area around that job-to-job sourcing environment. The notion of job-to-job sourcing refers to buying organizations that produce standard and or customized machines, parts, etc., based on a job-to-job sales environment. In other words, the organization builds only to customer orders and places purchase orders against booked or confirmed sales orders. Here we often see the purchase strategy defined as “taking advantage of the spot price of the day. But does that strategy create a competitive advantage for the manufacturer? We’d contend, likely not. It might not create a disadvantage but it certainly does not allow the manufacturer to compete on the basis of raw material sourcing prowess. We would add that if your incumbent supplier supplies to others within your industry, the chance that he has provided your firm with better pricing than your competition decreases because he is naturally hedged by having a greater chance of winning the business either way! In other words, your supplier has no incentive to actually provide you with a better cost structure than your competitor.
Question for buying organizations: Does your supplier offer you a range of pricing options such that you can create a competitive advantage through the acquisition of lower cost material in rising markets vs. your competitors? Does your incumbent supplier currently supply to other firms in your industry? What competitive advantage does your incumbent supply you with that you KNOW he doesn’t supply your competition with?
MetalMiner and its sister site, Spend Matters, along with Nucor, will host a live simulcast, International Trade Breaking Point on March 1, 2011. If your company sources products from overseas, you will not want to miss this half-day event: