Last week, I took part in a Supply Chain Brain webinar with CombineNet exploring a range of predictions for sourcing and procurement in 2012 as well as how organizations can address them directly through strategies, organizational structure and resources, technology, and general market awareness. As one example, even though we've written extensively about the volatile and falling Euro and economic uncertainty within the European union (download a compendium on the topic here), I touched on a number of the most important elements to consider from a sourcing strategy perspective in this area during the webinar.
The approaches I shared include factoring in raw material/commodity pricing strategy in context, including any potential arbitrage opportunities that could result from underlying volatility (e.g., producer prices not changing as quickly as currency movements, whereas underlying material elements and surcharges such as energy or transportation might actually be more susceptible to rapid changes in response to the market). On this topic, we also explored strategies involving optimal contracting arrangements with suppliers -- and arrangements suppliers want to push -- based on terms and currency. We also touched on the importance of commodity management tools, contract management and spend analysis -- not to mention how to get creative with sourcing strategies using advanced sourcing approaches.
I particularly liked one of the case examples about how advanced sourcing approaches can reduce supply risk that CombineNet's Greg Holt explored during the webinar. He shared the example of an industrial company purchasing steel tube on behalf of four manufacturing facilities (all in China). The incumbent supply base consisted of a mix of Asian suppliers from China, Japan and South Korea (among other countries). In order to reduce supply risk, the sourcing organization made it a condition of the bid that they would limit their dependence on any single supplier to a certain percentage of the total spend and at the same time, would limit the percentage of Japanese and South Korea suppliers shipping to specific facilities (as a means of further reducing risk given geographic and other supply risk concerns).
The end result was a bid that constrained the award decision to a total of four suppliers winning business, with between two and three suppliers shipping to each plant. And less than 25% of the volume for a particular plant could come from a specific Japanese or South Korean supplier. The buying organization also mandated that at least 40% of each award decision (on a plant level) would go to Chinese suppliers. Using the advanced sourcing technology and applying these types of constraints to run different scenarios, the sourcing organization was able to place a specific value on the cost of the low risk buying decision vs. the low-cost one. As Greg simply puts it: "there is a cost tradeoff for every decision [constraints add costs]; optimization [is what] helps you quantify the cost" and gain alignment among stakeholders, in addition to driving to an optimal decision based on a variety of cost and non-cost factors.
In another example highlighting the potential for optimization to change sourcing approaches, Greg shared one means of applying price index variation analysis (using underlying price indexes) as part of the sourcing equation in the case of packaging (corrugated). Under this approach, the general steps are as follows (as CombineNet shared):
- Collect supplier's price adjustment to the index in an RFI
- Use a Cost Model that includes the Adjustment based on index fluctuation
- Adjust Index Price to conduct sensitivity analysis on future index prices
In terms of the questions you might ask suppliers as a means of gathering data points to factor into the analysis of different offers, for example, the "quarterly price adjustment percentage based on every $10 change in linerboard cost (with a specific baseline cost noted)." Then, provided you know invoice payment terms, you can begin to create a cost model from this and related information that has been collected. A basic cost model in a sourcing toolset might look as follows (per Greg's example): (Paper Cost (per box) x Price Adjustment %) + Bid Input Cost with the Bid Input Cost as follows: Paper Cost (per box) + Print Cost (cost per numbers of colors and % coverage per box) + Setup Cost (per box) + Conversion Cost (per Box) + Freight Costs (per Box).
With this information, it's possible to evaluate the "proportion of the commodity price that makes up a total price" including the "percentage of total price attributed to commodities" and the "measure of the commodity in the final product." And then, using sensitivity analysis, it becomes possible "to determine if certain suppliers will provide a better total cost as commodity prices increase or decrease. It's even possible to evaluate these changes in the context of different pricing for linerboard (or another price index, for another commodity input in a different category) based on regional pricing, so as to compare different sources of supply from different markets. However, we all know corrugated tends to be a fairly local market hence this example is more relevant in evaluating global and regional sourcing decisions for other direct materials categories.