The world of direct material sourcing and procurement has shifted. Replacing the traditional single-minded focus on cost cutting is a more holistic approach that considers quality, risk, and product innovation as well as cost.
"Cost savings are great, but what's really happening is a transformation to compete in a global economy," says Dan Willmer, vice president of spend management at Ariba Inc. (Sunnyvale, CA), a provider of spend management products, including tools for contract management and contract compliance, plus a contract workbench to help suppliers and buyers hammer out terms and conditions.
As a result, new emphasis is being placed on process optimization and collaboration both internally and with suppliers. "Execution is not enough," explains Patrick Scholler, director of the Procurement Competitive Edge Group at HP. "We need to go to the next step -- optimization -- not only within functions but across functions," he says.
There's also pressure to change how business is conducted because of compliance mandates, reports David Hope-Ross, senior director of procurement applications at Oracle Corp. (Redwood Shores, CA). With regulatory requirements in place like Sarbanes-Oxley and RoHS (the EU's Restriction of certain Hazardous Substances in electrical and electronic equipment), attention must be paid to creating the audit trails that ensure compliance.
Establishing the Odds
One highly regulated company, Ensign-Bickford Aerospace and Defense Co. (Simsbury, CT), a maker of weapons systems components, relies on software from IFS North America Inc. (Schaumburg, IL) to automate the tracking of material in and out of its facilities as required by various federal agencies. With the IFS procurement tools, the company also can assign incoming inventory and costs to specific projects.
"The software helps identify items used across multiple projects," says Trygve Ronningen, vice president of sales for IFS North America. Consolidating orders boosts volumes and expands Ensign-Bickford's buying power, since higher volumes generally mean lower prices.
To counter rising costs and price volatility, especially for energy, many manufacturers are turning to options-based contracts and index-based pricing. These types of negotiations can guarantee the supplier a certain level of business and the buyer a certain price or price range for a specific timeframe. It also overcomes some of the weaknesses inherent in traditional forecasting.
One company that has embraced this concept is HP, which has drawn on the methodologies of Wall Street to create a procurement risk management (PRM) solution that helps its managers make better decisions about future demand, supply, and pricing.
"PRM uses financial engineering to manage the uncertainty in the procurement process," Scholler explains. Five robust math and statistical tools in the homegrown PRM solution crunch numbers from hundreds of potential scenarios to determine the likelihood of various outcomes. Knowing the probabilities involved in any given scenario gives managers the confidence to make commitments to a supplier about volume levels and prices.
HP has filed five patents related to PRM and uses the software throughout the company. In 2005, the solution earned the firm a Supply Chain Innovation Award from the Council of Supply Chain Management Professionals. To date, it has saved HP an estimated $100 million on roughly 100 contracts with a combined value of approximately $10 billion. "Our question now is, 'Can it be adapted to non-procurement situations?' So we're looking at other applications in the company," Scholler says. HP has also incorporated the methodology into its services offerings, allowing other manufacturers the chance to test its benefits.
Also key to optimizing the purchasing/sourcing function are spend management tools that pull data from various sources and analyze it in multiple ways to identify opportunities for process improvements. For example, Oracle Sourcing from Oracle Corp. (Redwood Shores, CA) generates recommendations after analyzing various combinations and permutations to balance cost, quality, risk, and product innovation as well as "what if" scenarios. This is done by weighing factors the user wants to consider, such as price, incumbency, minority-owned businesses, location, transit time, and associated tariffs. Purchasing pros still make the final decision, but they can react much faster since they no longer must sift through reams of data to identify the best alternatives.
Cost, of course, remains an important consideration, as evidenced by the popularity of offshoring and auctions, or e-sourcing. "E-sourcing is pretty standard now in the industry, and we are actively deploying it throughout the company," Scholler reports. HP relies on a commercial platform that Scholler declined to identify, and has spent about $40 billion via e-sourcing since it began using the technology.
Along the way, HP learned that how an auction is organized is crucial to its success. To optimize results, researchers from HP Labs have drawn on game theory to identify the ideal parameters. Much to their surprise, they discovered that best practices are not necessarily intuitive. "In fact, some best practices are actually counterintuitive," Scholler remarks.
HP also has discovered that e-sourcing boosts efficiency by automating requests for quotations, requests for proposals, and the price negotiation process. In addition, centralized data storage improves data security, tracking, and reporting, and simplifies audits.
"With this system, the data is readily available," Scholler says. Audits that once took days or weeks now can be accomplished in hours. Although savings attributable to e-sourcing have yet to be quantified, Scholler believes the impact has been significant.
Strengthening Collaboration
Procurement & sourcing innovators also are paying more attention to collaboration, both internally and externally. Internally, Oracle's Hope-Ross says, there is closer collaboration between the procurement and design functions. With this cross-functional approach, commercial implications are considered early in the design process. This not only allows new designs to incorporate parts and components that are already being purchased, but also helps ensure use of approved suppliers, and discourages designs that give a single supplier exclusivity.
Collaboration with suppliers is on the rise, too. In fact, some consumer packaged goods companies are pushing their top regional suppliers to perform on a global level. Although giving a good supplier partner more business has advantages for both parties, care must be taken not to eliminate all the competition from the marketplace.
"Without competition, when you go out to re-bid a contract, you might have trouble negotiating good pricing and service levels," warns Robin Shahani, project director in the supply chain practice at EquaTerra (Houston), a process improvement consultancy.
With a combined direct and indirect spend of $60 billion per year, HP views collaboration with suppliers as imperative. The company relies on several best practices tools to interact with its contract manufacturers and original equipment manufacturers (OEMs).
The first is BOM (bill of material) Analysis. "We work with many partners, and sometimes we delegate procurement to them," Scholler says. The BOM Analysis tool reviews bills of material to ensure that parts and components are bought at competitive prices. Developed exclusively for HP by a third-party resource, this tool consists primarily of a huge database of prices as well as part number synchronization to ensure apple-to-apple comparisons. This is essential since HP and its many suppliers often use different part numbers for the same item. Now Web-enabled, the database can receive quotes from outside the company.
"We analyze close to 1,000 bills of material each year," Scholler reports. "We typically find that there is a difference between what we are supposed to pay to the contract manufacturer or OEM and the best price we know about." Identifying and correcting these disparities saves HP more than $100 million per year. The system has been in use for about five years, and the company is continuing its rollout, with BOM Analysis ultimately to be used by business units throughout the company.
For items HP buys to supply its contract manufacturers and OEMs, another home-grown tool, Buy/Sell, provides a competitive advantage. Initially developed about 10 years ago, Buy/Sell allows HP to consolidate orders and avoid shortages of critical components such as hard drives, microprocessors, and memory -- without revealing prices to its contract manufacturers and suppliers. In practice, HP buys the components it wants to protect and then resells them within seconds to its contract manufacturer or OEM, Scholler explains. "It's a virtual transaction; we don't ever own the inventory. This process not only protects purchase price confidentiality, but also protects the supply allocated to HP in a contracted environment," he adds.
For many manufacturers, moving to a higher level of collaboration with suppliers requires an upgrade of supplier rating programs. Ensign-Bickford, for example, uses software from IFS to consolidate information about vendor quality, cost, historical performance, and incoming material inspections.
"IFS allows us to connect nonconformances directly to the supplier and track on-time performance," reports Bruce Mortimer, director of business administration at Ensign-Bickford. This information is then tied to a narrative analysis written by the company's buyers/ planners. "Before, we had to pull information from four different places to populate an Access database," Mortimer recalls. The new process not only streamlines Ensign-Bickford's material flow, but accelerates payment for vendors.
Another manufacturer that automatically monitors supplier nonconformances and corrective actions is Cequent (Plymouth, MI), a maker of automotive accessories. Cequent's Global Quality System relies on enterprise quality and compliance management tools from IQS (Cleveland) to maintain records for supplier scorecards, simplify communication with suppliers, and control documents like engineering change notices. "We reduced supplier PPM from over 3,000 per month to less than 300 per year," reports Kreg Kukor, director of global quality systems at Cequent.
As these companies can attest, innovative thinking in sourcing and procurement only began with cost; these days it includes much more, and many more rewards.