Optimization Should Drive Complex Direct Materials Decisions

Paul Martyn penned a good post over on Combine Notes last month that got me thinking about how best to explain the power that optimization can bring to the decision support process for direct materials sourcing practitioners. Many practitioners I speak with in manufacturing -- in fact the great majority, I would argue -- have a very limited understanding about the true applicability of optimization for complex buying decisions.

But optimization approaches, when used strategically, go far beyond the classic "split of business" scenarios that many of us are used to. In fact, optimization is most powerful when used to truly look at total landed cost that incorporate such factors as make versus buy, logistics / transportation, tax / tariff duties, and risk. As Paul discusses, "several of our clients are looking at how their decisions are dependent, including decisions on supply, manufacturing (where to source manufacturing), distribution (direct or through distribution center), transportation carrier and transportation mode (full truck, rail, flatbed, less than truckload, air, etc). This type of total landed cost analysis is uncovering orders of magnitude more savings than more arcane sourcing processes that focus exclusively on squeezing supplier margins (a component easily handled with optimization based sourcing practices)."

I also like what Paul has to say regarding the fact that procurement and sourcing negotiations are not just between buying organizations and their supply community. Rather, "Good spend management teams understand that their negotiations are with their suppliers AND their operations [organizations]." Paul's logic, which I would not dispute, is that decision modeling and optimization tools can help procurement organizations to make the best possible margin and value decisions staring with design engineering processes and going all the way through to logistics, transportation, and inventory management.

For example (mine, not Paul's), consider whether a series of metal stamped parts that go into a sub-assembly should be made in house, outsourced to a single supplier (or multiple suppliers), or dual-sourced on the piece part level. And how would you best look at this decision in the context of global sourcing and transportation costs, supply risk, and other variables. Is a supplier that is willing to offer a JIT program for all the stampings and ship parts at a Six Sigma level who is 3% higher on a unit cost basis than a combination of suppliers that can provide a better piece part price, but do not offer the same quality and delivery levels the better partner? Or not? Advanced optimization approaches that can help an organization model this decision to arrive at the best possible answer for their specific needs and risk tolerance levels.

In summary, Paul's main argument, I believe, is that you can't separate out these decision factors from each other and achieve an optimal sourcing result. It is precisely the combination and intersection of the various factors which enable the creation of an approach which yields the best total cost approach in a complex, global manufacturing environment. Now, I doubt that optimization makes sense for all types of sourcing approaches as a stand-alone tool, but when you combine it with competitive negotiation approaches as part of the process, it's hard to go wrong with including such capabilities as a core part of your decision support arsenal. Thanks, Paul, for such an insightful post! And here's an end of year virtual toast to CombineNet's growth and evangelism of optimization.

Jason Busch

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