Key Considerations for MRO Outsourcing

Spend Matters welcomes a guest post from Timothy Yoo, Principal at Archstone Consulting.

Manufacturers face continual pressure to lower their cost structures. As a result, more and more companies are considering MRO Outsourcing. Check out a previous article we wrote on the subject here.

As you probably know, MRO refers to maintenance, repair and operations. It's often used to describe the indirect expenses associated with keeping a manufacturing plant running. Plant engineers typically consider it anything but direct materials and labor, but that's too broad of a definition. Procurement would define MRO based on "source-able" subcategories (industrial supplies and spare parts, third-party maintenance services, internal maintenance operations). If we struggle so much with a simple definition of MRO, the potential pitfalls in trying to outsource it become clear. To help in managing your current MRO provider, here are five key considerations:

  1. Have a clear objective or goal - Cost savings is typically the main driver, but be specific (improve cash flow, reduce inventory, reduce obsolescence, reduce purchase price costs, etc.). If your plant's primary goals include quality and uptime, then a pure cost savings goal for outsourcing might miss the mark. Outsourcing MRO has the potential to transform your MRO processes, as providers should improve efficiency and quality. Some providers even offer technology solutions for improved order and inventory accuracy and tracking, and better spend visibility.
  2. Clearly define your savings methodology - MRO might be the most difficult category to track savings in -- including hundreds of vendors with very little enterprise spend visibility, especially since the majority of MRO purchases are non-repeat without a historical purchase price to use as a baseline. Whatever methodology you use, ensure the provider agrees up during the proposal, before pricing is finalized.
  3. Define your current state - "Unless you know where you are, how do you know where you want to go?" For savings purposes, find (where possible) your baseline pricing for all parts and even services. It's even more important to baseline process measurements to understand current performance to set provider service levels and improvement targets. You'll need detailed current state definitions and metrics for different providers to accurately bid.
  4. Be very specific in defining the scope of services being outsourced - When determining this, there may be certain critical processes (like equipment monitoring or part repairs) where the risk is too great to for your company to transfer the responsibility to someone else. You might already have a world-class strategic sourcing group, so why not just transfer day-to-day operational buying? But would that include services, OEM parts, etc.? What about the invoice to payment process? Will that managed by them, and will you receive a consolidated invoice from the provider? Or will they simply input each transaction into your ERP system? The most common MRO processes in an outsourcing relationship are strategic sourcing of MRO subcategories, parts buying (and potentially services and OEM parts) and receiving, managing the invoice to payment process, performing equipment repair and maintenance, managing storeroom operations, monitoring equipment, etc.
  5. Understand the outsourcing deal economics - Complex MRO outsourcing deals unfortunately often get inked without a true understanding of the exact deal economics, as executives are blinded by the promise of large savings numbers -- particularly if MRO was previously unmanaged or under-managed. Stop and review the true deal economics and ensure they seem reasonable and sustainable to all stakeholders (manufacturing operations, plant engineering, safety, quality, procurement and finance). Where are the true savings coming from? Are the savings realistic? Are they sustainable year-over-year and if not have they factored that into the savings estimates?

    Oftentimes integrated suppliers include a markup on all P2P for the headcount onsite doing the buying. The markup is typically offset by purchase price discounts gained by aggregating pools of spend or buying lower priced substitute products. This nominal markup on MRO parts may seem to make sense now, but what happens if your purchase volume and spend dramatically increase? Should you still include OEM purchases with the same markup rate since the integrated supplier isn't getting any discounts on OEM items effectively simply increasing your costs?

    If you're outsourcing actual FTEs that do buying or manage the storeroom, these services will mostly continue onsite -- so how will they effectively manage what you already have, but at a lower cost? The answer is typically by making do with less people or with lower salaries. Be sure to review proposed FTEs for whatever operational efficiencies they say can be gained and whether it will lead to decreased FTEs. Collect labor rate cards by position to ensure that providers are being realistic for onsite labor costs. Underpaid provider employees means lower skilled talent and higher turnover, leading to churn. Another cost savings trap is to simply lower service levels. If your storeroom is running 24/7, providers may propose manning storeroom 9-5 to cut on labor costs -- but that could cause serious operational issues.

MRO Outsourcing continues to be an attractive and viable service delivery model for manufacturing (and many non-manufacturing) companies. Similar to other outsourced deals, ongoing management and governance of the relationship is critical to long-term success. Most major mistakes in MRO Outsourcing can be avoided altogether with additional due diligence during provider selection and final contracting. Hopefully these important key considerations can help you in a long and healthy outsourced MRO provider partnership.

-- Timothy Yoo, Principal, Archstone Consulting

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