Note: The following article is excerpted from the book, Managing Indirect Spend: Enhancing Profitability through Strategic Sourcing, by Joe Payne and William R. Dorn, Jr. Published by John Wiley & Sons, Inc.
One step that is commonly overlooked while sourcing indirect spend categories is to look further down the supply chain, to your suppliers' suppliers, and even to their suppliers. In these scenarios you work closely with your first-tier suppliers and assist them in reviewing their supply chains to see if there are opportunities for cost reduction with their suppliers, which will then, in turn, translate into savings in the product you purchase for them.
A few years ago the authors of this book were engaged to assist in a strategic sourcing and cost-reduction initiative to supply gas containers to a national chemical manufacturer that was under severe pressure to reduce the costs of its indirect and direct materials, but was already receiving best-in-class pricing from its supply base. The organization asked us for help in finding creative ways to reduce the price, since traditional sourcing methods were not producing any savings opportunities.
The first step of this project was to break down the components of the finished product that our customer was ultimately selling. In this case, the end product merely consisted of a gas or chemical, the container it was sold in, and freight costs (receiving and shipping to distribution points). However, diving deeper, we learned that the container itself consisted of two parts: the vessel and a valve cap that sealed the contents in the container.
Upon further investigation, we learned that the chemical manufacturer was in fact purchasing containers with the valve preinstalled, but was also buying valves independently from another vendor. We learned that federal regulations had changed, and all existing containers were required to have their valves swapped with a new type of valve that had improved safety features. Our customer was selling new containers with the proper valve, but also had a separate profitable division that was responsible for replacing the valves on the millions of containers that were already in the marketplace.
Immediately, we identified an opportunity for price improvement, because the product lines all had similar quantities of component materials associated with them. We knew if we could go to market with the entire valve spend, it held the potential of being much more attractive to suppliers than two separate spends of half the size, as was the current case. However, as the matter currently stood, we also knew that we were not going to generate substantial savings, and we needed a way to identify further opportunity. The solution lay in aggregating the valve spend and getting the container supplier out of the business of manufacturing containers with valves attached.
Before we went out to market with the entire spend of valves, we held internal discussions about how the container manufacturer would handle us telling them that they would be losing the valve components of the business, and we also needed to conduct internal studies to determine the cost impact on our client's staff of having to assemble in-house the container and its valve. We decided the best course of action was to be forthcoming with our supplier and see what suggestions it might have.
Our team was careful in their approach in dealing with the supplier, due to internal concerns that the supplier might be upset that they were losing a piece of business. However, to our surprise, the supplier was extremely happy to meet with us and, in fact, had discovered the same pain point: the valves. The supplier was the leading manufacturer of chemical containers in North America, and was running into similar issues in that the valves supplied with the containers were almost as expensive as the containers themselves. The supplier meeting led to a brainstorming meeting with procurement teams from that organization and the chemical manufacturer. Ultimately it was decided that we could use the combined spends from both organizations to leverage the valve-supply base. With the aggregate spend of both organizations, the volume was four times what any individual segment had previously purchased on their own.
After helping the supplier conduct a global sourcing initiative for the new valve spend, savings of 39% were ultimately achieved. However, we now had a new issue: the second-tier supplier did not want to receive multiple orders from different companies and purchasing managers, nor did they want to ship to multiple facilities in North America. Our supplier and our client got together again, and turned this problem into an opportunity.
There was, in fact, a freight saving opportunity for shipping all of the valves in full containers to our existing supplier, rather than partial containers to our client and the supplier. Additionally, we learned that the supplier had excess manufacturing and staffing capacity and could act as the intermediary for placing orders for valves for a low margin.
As an end result, our client is now purchasing valves directly from the container manufacturer, at a reduced price, and is receiving the benefits of the lower-priced valves on the assembled containers that it purchases. The container manufacturer not only reduced their costs, but increased their profit margin with other customers who did not receive the benefits of the lower valve pricing.