Week 07_Supply chain

Developing a Supply Chain Strategy to Grow your Business

2Proprietary to Establish.
SUPPLY CHAIN STRATEGY // Primary Functional Areas to Cover in a Strategy
Procurement Service
Cost
Strategy
(Systems/
Visibility)
Strategy Focus
(Customer Impact)
Logistics
Transportation
Warehousing
Inventory

Cost
Service
Risk
Suppliers
Typical Correlations
High-Level Initial Strategy
• Single Supplier
• Multiple Suppliers
• Suppliers as Partners
• Collaborative Procurement
Factors Affecting Cost and Service
• Number of Suppliers
• Distance
• Supplier Size
• Volume
0 1 2 3 4
PROCUREMENT STRATEGY // Sourcing as an Advantage

Understanding cost drivers is the key to knowing what affects prices
charged by suppliers which then enables you to understand where and how
to lower prices most effectively to maximize value to your organization.
A Cost Driver is…
• Elements of cost structure that impact pricing.
• Elements are a mix of material, service and technical requirements.
• Combined elements determine total cost and resulting RFP price offer.
It is Important Because…
• Provides insight into mechanisms influencing supplier prices.
• Helps identify savings opportunities.
• Essential to developing effective pricing grids for RFPs.
• Can increase competition and avoid non-value added costs such as distributor markups.
PROCUREMENT STRATEGY // What is a Cost Driver and Why is it Important?

5. Associated Risks
• Interest rate changes
• Political risk
• Currency risks
• Inflation risks
• Unions
• Lead times
• Obsolescence
PROCUREMENT STRATEGY // Cost Drivers: What are Major Cost Drivers?
1. Cost Inputs
• Initial purchase cost and
underlying factors
• Freight and transportation
• Quality assurance
• Service and repair
• Preventative maintenance
• Operating costs
• Disposal costs
4. Specifications
• Technical specifications
and after sale service levels
required affect pricing
• Required certifications
• Conformance to engineering
and quality standards,
packaging, delivery
2. Contract Terms
Contract Terms/Structure:
• Volume being bid
• Length of contract
• Elements with a direct impact
on supplier’s cost to serve a
company account
3. Competition
• Industry competition
• Position in the market
• Vendor situation (e.g., new
vendor entering a geography,
incumbent protecting
business)
Cost Drivers
Five Major Cost Drivers
to Determine Pricing

PROCUREMENT STRATEGY // Cost Inputs
The primary “Cost Inputs” for a product or service are the initial purchase
costs, operating costs, maintenance costs, etc. that are needed to acquire
and use the product and/or service. A good understanding of the inputs
and their impact on price will help you define the most appropriate pricing
mechanism to negotiate the best possible prices.
At the end of this step, you should:
• Have a good understanding of the different cost components for a product
or service, as well as, how a supplier fits them together mathematically to
derive their total cost of providing the product or service.
• Understand any fluctuations in prices of inputs that go into making the
product or providing the service.
• Identify any future external events or changes that may impact the cost of
inputs and steps you can take to mitigate that impact.
Suggested Analysis Approach
Begin by determining the breakdown
of input cost components (materials,
labor, freight, maintenance, etc.) of a
product or service to be purchased,
and then study the impact of
fluctuations in price for each of the
disaggregated components.

PROCUREMENT STRATEGY // Typical Product Cost Structure
For purchasing products, materials input costs are often the key cost driver.
For example, if raw materials cost is found to represent 70% of total input
cost required to manufacture a product, isolating this cost component and
understanding the dynamics of the commodity industry can provide you with
knowledge to develop the most appropriate approach to achieve the best pricing.
Example
Factor % Total Cost Comments
Fixed
Costs
Variable
Costs
Profit
• Infrastructure
• Overhead
• Fixed costs are plants, equipment, full-time worker salaries, etc., which change gradually, and,
therefore, very rarely impact prices from a sourcing perspective.
• However, you may occasionally find that a supplier’s capacity is limited and it, therefore, cannot
take on additional business. At this point, fixed costs become important as additional volumes
are not attractive to the supplier due to the incremental fixed cost investment required.
• Variable cost components such as raw materials are often the key cost drivers with the
greatest impact on price from a sourcing perspective.
• Your research should focus mainly on these costs to under-stand raw material costs and their
potential impact on pricing.
• A good understanding of general profit margins in an industry is very useful during negotiations
– and helps you understand how much room a supplier has to offer lower prices.
20%
70%
10%• Profit
• Raw Material
• Transportation
• Installation
• Swing Shift Labor

PROCUREMENT STRATEGY // Typical Service Cost Structure
For purchasing services, labor usually is the biggest overall cost driver.
Lower prices in service commodities can be achieved by understanding the
profit margins charged by the supplier as labor costs are usually similar
across all suppliers and the opportunity for savings primarily comes from
negotiating down a supplier’s profit margins.
Example
Factor % Total Cost Comments
Fixed
Costs
Variable
Costs
Profit
• Overhead • Overhead is the primary fixed cost in services and should not have significant impact on
the overall cost of services, however, understanding of fixed costs may help you better
understand variances in pricing from different suppliers
• Labor makes up a significant portion of cost of providing services and thus the primary
driver of overall costs
• If any material is part of providing a service, both labor and material costs drive the overall
cost of service
• A good understanding of profit margins in an industry is very useful during negotiations –
and helps you understand how much leverage a supplier has to offer lower prices
10%
80%
10%• Profit
• Labor
• Travel Expense
• Material

Total Cost = Resin (Petroleum) + Transportation + Labor + Profit
100% = 70% + 10% + 5% + 15%
PROCUREMENT STRATEGY // Plastics Example
It is important to choose the most appropriate pricing structure/mechanism
that is consistent with the industry dynamics to achieve the best pricing.
The Plastics example below illustrates how oil industry dynamics affect the
use of fixed vs. indexed price contracts.
Fixed vs. Indexed Pricing in Contracts
Plastics Cost Structure (Illustration)
Sample Crude Oil Prices
0
10
20
30
40
50
60
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Observations
• Petroleum accounts for a significant portion
of the total cost of plastics
• Oil prices affecting petroleum prices
fluctuate constantly making it difficult for
the supplier to predict future costs with
certainty.
• Fixed price contracts for a commodities in which
the raw material prices vary significantly, are
sub-optimal.
• If a fixed price contract is used, the supplier
has to build in a significant risk premium to
maintain margin, resulting in artificially high
prices.

PROCUREMENT STRATEGY // Contract Terms - Contract Review and Benchmarking
Contract structure and terms can have a significant impact on prices.
A thorough review of all the contract terms in the current contract and
understanding their impact on prices are essential to creating a contract
that benefits both parties without impacting prices.
Identify Contract
Termsthat Impact Cost
Compare Against
Other Pricing in the Market
Summarize Potential
Changes that May Result
in Lower Prices
Contract Review and Benchmarking Goals
• A good understanding of current contract terms and
conditions that impact cost.
• Opportunities for changes or modifications to current
contract terms or conditions based on research.

PROCUREMENT STRATEGY // Sample Contract Terms that Impact Price
(in Addition to Total Contract Value)
In addition to the total value of a contract, some key contract areas to
focus on during the contract review process are outlined below. Improperly
structuring these areas of the contract can significantly increase prices.
Typical Scenario Questions to Ask Optimum Scenario
Contract
Award
Pricing
Structure
Contract
Termination
• Multiple suppliers on a contract or multiple
contracts within a category can be a common
occurrence.
• Why maintain multiple contracts or use
multiple suppliers?
• Can the contracts or suppliers be consolidated
without compromising the need for flexibility?
• Single contract with one primary vendor.
• Additional vendors on contract only if the
situation warrants.
• Many companies prefer fixed pricing for the
life of the contract. This compels suppliers to
build a significant risk premium in categories
that are subject to raw material price
fluctuations.
• Can price in this category be indexed to
reduce risk premium?
• How can pricing risk be managed to limit
price changes within the company’s risk
tolerance?
• Use of the most appropriate pricing
mechanism that minimizes the impact of
changes in cost of inputs and minimizes the
supplier’s risk.
• Some companies have contracts that allow
termination for performance or termination for
convenience clauses - these do not offer the
same flexibility.
• What is the impact of the company’s
termination clause on prices?
• Would the supplier benefit from being able
to terminate the contract under certain
conditions?
• Utilization of proper contract termination
clauses that benefit both parties.

PROCUREMENT STRATEGY // Competition
Suppliers determine their offer prices based on the amount of margin they
believe they can “get away with” depending on the level of competition for
the product/service in the local area.
Questions to Ask
• How many proposals/bids has your company received historically for this category?
• Are there any constraining factors in your company’s requirements – RFP/ITB or contract structure that discourages some suppliers from
bidding?
• What are the potential changes that would encourage some suppliers that have been unable to or not been willing to participate, e.g.;
»» Change award decision by smaller geographic regions to encourage smaller/local suppliers to participate.
»» Evaluate proposals by product sub-groups to encourage niche players to participate.
»» Encourage larger suppliers to utilize sub-contactor relationships with smaller or niche players under a master supplier relationship.
• Are service/support expectations too high for the suppliers in the local area?
• Is the incumbent supplier likely to lower pricing to protect its business?
• Have any new suppliers entered the market who are willing to offer low pricing to establish market share
Evaluate the competitive landscape for the commodity, specifically within your
company’s geographic area to identify opportunities to increase competition.

PROCUREMENT STRATEGY // Competition
Your research should provide all the information you need to
ensure you can increase competition as much as possible.
At the end of your research on competition, you should have:
• A good understanding of the competitive landscape for the commodity in
your company’s geographic area.
• A potential plan for increasing competition, if possible, by creating
conditions that encourage or allow for additional suppliers to participate in
the procurement process.
• A list of changes to the quality of product or the level of service that is in-
line with your needs and that also fits with the capabilities of the suppliers
in the region.

PROCUREMENT STRATEGY // Specifications - Review Process
Commodity specifications and service requirements have a direct impact on pricing. Ensuring your required
specifications are appropriate for their intended use and rationalizing specifications as necessary, whenever
possible, can significantly lower the pricing for the company.
Profile Current
Specifications
Benchmark Against
Other Companies
Finalize Revised
Specifications
Discuss Opportunities
for Specification Change
with Users
• Create a profile of the product/
service specifications from the
contracts/ procurement documents.
• Summarize the after sales support
and delivery requirements.
• Review specifications with the
users to understand the factors
driving the current specifications.
• Compare your specifications
against other companies.
• Identify discrepancies in
specifications and evaluate
opportunities for rationalizing
specifications for cost reduction
without compromising on
service/quality.
• Create options to change to
new specification profiles.
• Present revised options for different
specifications profiles to users and
commodity experts at your company.
• Quantify potential cost/benefits of
proposed specification changes.
• Obtain feedback on the proposed
changes and modify proposed
changes with end user feedback.
• Finalize new options for
specifications and service levels.
• Incorporate new options for
specifications and service levels
into procurement documents
(RFP, etc.) along with current
specifications, so you can compare
the cost differences between
current and potential specifications.
Conduct adequate research to develop sufficient advance category knowledge
to facilitate a more constructive discussion with the users and achieve their
buy-in for including any changes to specifications in your RFP process.

Three key specifications cost drivers are outlined
below that have a direct impact on supplier pricing.
Product/Service
Technical
Specifications
Award
After Sales
Service/Support
Requirements
Delivery
Requirements
• Technical specifications (for example, an 80GB hard drive instead of a 20GB hard drive) have a direct
impact on the price paid for the product or service. Rationalizing the technical specifications to match,
but not exceed, the end user’s requirements could significantly lower the cost of the product or service.
• Requests for excessive after sales support (for example, 24-hour live customer service) will increase
the cost burden for a supplier. Customizing after sales support to the end user’s needs and considering
varying the service by region or product group can lower supplier’s costs and pricing.
• Transportation costs to deliver a product/service is a significant part of the total cost. Identify
opportunities to reduce costs by lowering minimum delivery time and negotiating separate transportation
costs to different locations vs. one single transportation charge.
PROCUREMENT STRATEGY // Specifications Cost Drivers
Description

In addition to the general purchase, maintenance and quality
issues, there are other risks associated to certain purchases.
Interest Rates
Inflation
Currency Risk
• Interest is the amount paid on borrowed capital. During periods of increasing interest rates, the cost of
borrowing goes up which may affect the lease or purchase of capital equipment. Interest rates also affect
the cost of inventory which may affect how much or how little you buy at one time.
• Inflation is the rise in the general level of prices for goods and services over time. During periods of high
inflation, buyers may choose to make purchases sooner rather than later to avoid paying higher prices or
adopt a “hand to mouth” buying strategy.
• Currency risk, or foreign exchange risk, is the risk that arises from changing the price of one currency
against another. Hedging can reduce currency risk by locking in profit margins. You can hedge by taking
equal and opposite positions in the financial market by forward buying an amount of foreign currency
when a sale is made.
PROCUREMENT STRATEGY // Associated Risks
Potential Impact on Purchasing

Taxes
Sarbanes-Oxley
Political Risk
• Taxes directly affect the bottom line or profit. They may affect which suppliers you choose, where they are
located, and also may change the timing of purchases.
• SOX is a US federal law that was enacted in 2002 in response to a number of corporate accounting
scandals. The law requires “adequate internal control structures and procedures for financial reporting”
necessitating buyers to document the bid process, verify approval procedures, and eliminate having
expenses accounted for assets.
• Sources of supply in countries where there is a significant amount of political unrest can affect the
sustainability of your supply.

Unions
Lead Times
Obsolescence
• Be aware of ongoing labor negotiations, strikes and other union-related risks.
• Longer lead times need to be accounted for in the total cost of ownership model. With all things being
equal, a supplier with long or uncertain lead times provides less value to a buyer than a supplier with
shorter lead times.
• Products with quickly changing technology have higher obsolescence risks than a more stable product.
Buyers will not want to stock up on such items due to the high risk of becoming obsolete.

PROCUREMENT STRATEGY // Recap
• A good understanding of the cost drivers in a category is critical to
developing the most appropriate procurement approach to deliver value to
your organization.
• It is important to follow a logical approach to analyzing the cost drivers in a
category to ensure a comprehensive review.
• A thorough understanding of the cost drivers for a purchase and your ability
to articulate their impact on the price to the end user helps you gain their
trust and approval, resulting in purchasing being a strategic player within
your company.

LOGISTICS STRATEGY // A Network that aligns and executes the Business Strategy
The four main criteria to be considered when preparing a strategy:
Transportation
Analyzing transportation
costs and service levels
based on modes and
requirements.
Pools/Consolidations
Mode Optimizations
Number of Providers
Spot Rates
Order Cycle Time
Regional Warehouses
Customer-Specific
Outsourcing to 3PL
Deployment by Facility
Vendor-Managed
Customer-Specific
Made-to-Order
Risk Analysis for Unwanted
Factors
Forecast Validation
Key
Considerations
Warehousing
Determining the lowest
cost and staffing levels for
each required facility.
Inventory
Calculating the effects of
each concept on inventory
and service levels.
Risk Management
What-if analysis to
determine the robustness
of the logistics network.

TRANSPORTATION // Transportation, your Highest Spend, is Critical
Considerations
• Pool Points
• Consolidations
• Cross-Dock Opportunities
• Zone Skipping
• Route Optimization
• Mode Optimization
• Carrier Optimization
• Spot Rates
• Backhaul Rates
• Passing transportation costs to
customers with a margin.
• Not passing transportation
discounts to customers when
charging customers for freight.
One Day Air
32%
Two Day Air
13%
Ground
36%
Full
Truckload
5%
Less-than-
Truckload
14%

WAREHOUSING // Warehousing Costs Vary by Service Required
Considerations
• 3PL Outsourcing
• Customer-Specific
• Economies of Scale
• Regional Opportunities
(New Markets)
• Temporary vs. Permanent Labor
• Order Cycle Time
Deprecia(on and
Amori(za(on
10%
Lease
37%
Temporary Labor
20%
Permanent Labor
28%
Maintenance and
U(li(es
4%
Miscellaneous
1%
Labor
[PERCENTAGE]

INVENTORY // Inventory Affects Transportation and Warehousing
Considerations
• Deployment by Facility
• Vendor-Managed
• Customer-Specific
• Made-to-Order
• Fill Rate
• Inventory Ties Up Capital

RISK MANAGEMENT // Ensure Logistics Network can Handle Business Changes
Risk Considerations
• Transportation (Providers
Reliability, Fuel Price Changes,
Capacity)
• Taxes
• Rate Volatility - Sport Rate versus
Contractual
• Business Forecast Changes
• Volume Forecast Changes
• Customer Requirements
• Supplier Sustainability

SUPPLY CHAIN STRATEGY
• Procurement
»» Cost per Unit (Raw Material; Supplies)
»» Supplier On Time Delivery
• Logistics
»» Fill Rate (95%)
-- Complete Orders
-- Complete Lines
-- Complete Units
»» Transportation Cost as a Percent of Sales
»» Warehousing Cost as a Percent of Sales
-- Receipt and Putaway per Hour
-- Order Lines per Hour
»» Inventory Turns or Months of Inventory
»» Obsolete and Excess Inventory
»» Inventory Forecast Accuracy
KPIs (Monthly, Quarterly and/or Yearly)

Week 07_Supply chain

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Week 07_Supply chain