Effective Cost Reduction–A Desktop Guide

Dr. Tom DePaoli

Cooperative cost reduction efforts with suppliers demand a great deal of discipline and common sense. Never underestimate the amount of time and energy involved in significant cost reduction efforts. Pareto’s 80/20 rule is your starting point. Concentrate on your top 10 suppliers which for most companies are responsible for 40-80% of all money spent.

Consolidate Suppliers First

First you must consolidate your supplier base! Pick the right suppliers or the “best racehorses.” Be thorough and have a standard systematic process for supplier selection. Ditch the traditional adversarial relationship mode but be reasonably prudent in your commercial relationships. Nothing is more painful or costly than picking the wrong supplier and then having to de-select them. Shooting racehorses is very expensive! To attempt to manage or control your supply chain costs with a large supplier base is impossible and foolhardy. Insist upon financial sharing of data with your key or preferred suppliers. Have your suppliers help you process map or chart out your process. Give them some homework first. Encourage them to then make a formal presentation to a cross functional team of their understanding of your process. This is meant to be a shared learning process not a test. This guarantees that they have a good grasp of your process. It also cements the understanding of various functions in your own company. Departments begin to appreciate the problems of sister departments around material flow. Soon afterward have suppliers share their own process flow charts with you. Visit their manufacturing plants. This is an important starting point and immediately builds trust and puts all parties in a problem solving mode. The lesson here is that both parties must understand each other first before cost reduction improvements can take place.

Different Materials Demand Different Cost Reduction Strategies

Tailor your cost reduction strategies to the specific material or service characteristics. Your non-critical routine items such as MRO, office supplies, “rope, dope, and soap,” should not exhaust one iota of your energy or time on major cost reduction efforts. Get competitive prices only in these areas. Work with your selected preferred supplier to totally drive out the logistics and administrative costs. Let the supplier manage the materials and services in this arena. This is where the major savings are on these items anyway. Systems buying techniques, purchase cards, and EDI are just some of the best practices. Purchasing only needs to monitor these areas. Drive out all inventory, stocking, invoicing, and administrative costs. The supplier is in the best position to drive down these costs for you. They are also imminently more qualified to suggest material substitutions or better solutions.

For your strategic components or those materials or services that give you a technological or significant competitive advantage establish an alliance type relationship with your supplier. This is a long term “virtual corporation” type relationship. These suppliers become extensions of your company. Technological and communication exchanges must take place across all levels of both companies. Close “on site supplier” relationships are essential for this type of alliance to succeed.

Analyze the Supply Chain

When you do supply chain analysis remember that the earlier in the supply chain that an added cost or change occurs the more potential of savings for both parties. Encourage continuous improvement by offering to split 50/50 the first year savings of cost reductions with the supplier. Use your suppliers as educators with your people to introduce new materials or improvements. Encourage Total Cost of Ownership thinking and identify critical costs.

Find out what really drives the costs of your materials or services. Most product specifications are not challenged for years. Your supplier can often drive this change better than your own employees. Market conditions, volume, stability and lead time of orders, process efficiency, and scrap are all factors. Make sure you really understand what counts. Many cost accounting systems arbitrarily assign general overhead costs to particular material flow stages with no real basis of the true cost of that activity. If you have an activity based accounting system you have a head start on most companies.

Remit Creatively

Be creative on contracts with suppliers. If they drive down the cost of their materials and services via their expertise and consulting skills they should be rewarded for these victories. Restructure their contracts to treat them more as advisors and consultants not widget pushers.

Finally publicize your successes and recognize those who took risk in driving down supply chain costs. Your joint efforts will be richly rewarded.

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