Optimizing Supplier Relationships While Reducing Costs

Today, I'd like to welcome a guest post from Dr. Olga Raskina of Emptoris. Olga's comments on approaches to deploy sourcing and optimization to reduce costs provide a useful primer for anyone thinking about how to get more from their supply base -- without raising supply risk -- in today's challenging economic environment.

As more signs of troubled economy emerge corporate leaders are increasingly focusing on bringing supply chain management under tighter financial guidelines. A recent article in Supply Chain Digest highlighted the typical urgency felt by procurement managers to cut supply chain costs.

As I read the article, I thought about how the typical knee-jerk reaction to reducing costs has often had adverse longer term effects: strained supplier relationships, diminished quality and diminished reliability among them.

While managers preach the importance of strategic relationships and decisions based on total cost, we are sometimes too easily willing to sacrifice that mantra in an attempt to resolve short term financial issues. The SDC article quotes one procurement manager as saying, "Forget about all that strategic stuff. We need to lower our costs right now."

Of course, we can identify with the urgency. However, this mindset seems to ignore the possibility of cutting the costs while maintaining good supplier relationships -- and improving overall business value to the organization.

I would actually propose that a downturn can in fact be addressed in a way that is actually beneficial to an organization -- specifically in achieving these seemingly conflicting goals of costs vs. supplier relationships. The key to success, I believe, is in sourcing optimization.

Let me provide a brief case. As more and more companies become spend-conscious, the demand for certain products drops, leaving suppliers with more inventory than usual and an increased willingness to sell.

In this environment, many suppliers seek creative ways to decrease inventory and are often willing to negotiate new deals. These deals may take the form of volume discounts or better non-price terms such as decreased delivery time or improved warranties. And with such new offers, comes an opportunity for revision and reevaluation of the existing purchasing agreements (and strategy).

The ability to analyze all aspects of a deal is critical in taking advantage of these new market conditions. For example, a majority incumbent supplier might have invested in fuel efficient, alternative specifications that can meet the buyer’s requirements -- while a minority incumbent may have lost a large customer giving him more capacity to meet the buyer’s volume. An evaluation based primarily on costs may ignore these supplier realities.

Optimization, part of a bigger science called Operations Research, makes this analysis possible.

Operations Research, in a nutshell, is the discipline of applying advanced analytics to help make better decisions. Optimization, in turn, utilizes mathematical algorithms to rapidly solve a business problem by evaluating "all possible outcomes" (or many outcomes) and selecting those ones that yield the best solution.

When applied to supply chain operations, optimization helps the sourcing professional simultaneously evaluate thousands of different procurement inputs. This evaluation can take into consideration the global market, specific current supply chain conditions, and individual supplier conditions, and offers solutions that address the buyer's [and supplier's] goals in the best possible way.

Optimization goes far beyond simple spreadsheet-like comparisons. It helps ensure that no possible scenario or solution is overlooked and no money is "left on the table." Although it may sound intensive, with the correct application of technology it can eliminate weeks of tedious side-by-side evaluations that attempt to simultaneously analyze the inputs.

Optimization is often limited by the "human factor." According to different studies, a person can attend to 6 to 18 factors of evaluation simultaneously. However, as you know, any company-wide supply chain initiative involves thousands of factors and parameters, each affecting the bottom line.

Optimization-driven technology allows the procurement manager to evaluate the "new best state" of their supply chain and to react promptly. This could be as simple as relaying some or all key factors that affect a decision on suppliers.

By allowing suppliers to compete on more than just cost, you empower them to be creative. Once the suppliers understand the buyer's goals, they can offer alternatives based on their own competitive advantages, and avoid being squeezed on just price.

Offers based on these competitive advantages might include:

- Alternative Specifications
- Extended Warranty Terms
- Discounts on Packaging
- Rebates for Bulk Orders

Depending on how extensive or creative the buyer wants to get, the goals of a new relationship might also involve overhauling the supply chain risk structure. This might include, for example, contemplating a switch from a single source supplier to a multi-source scenario or a local to a global operation.

Knowing your true total cost, beyond just price, when creating a new supplier agreement is critical.

In sum, I would propose that there are three critical benefits that Optimization can impart in an uncertain economic environment:

* Rapid response to the changing market conditions, including the ability to renegotiate existing deals and quickly achieve better total costs;
* Rapid evaluation of suppliers' capacity, including the ability to rapidly add more suppliers to the operation;
* Ability to maintain and strengthen supplier relationships.

By making the negotiation about more than price, optimization allows the suppliers to be creative and offer more complex deals, compete on different direct and indirect cost factors, and not feel pressured to simply reduce the price.

Spend Matters would like to thank Dr. Olga Raskina of Emptoris for contributing these thoughts.

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