Ed Cross, Xchanging

Procurement Excellence in Manufacturing: How to Maximize Profit While Driving Increased Quality

April 11, 2013
A well run, proactive procurement organization working closely with other functional areas in the business and third-party suppliers can help drive significant benefits that materially impact the company’s profitability and cash cycle, and thus, the overall return on investment.

For many manufacturing CFOs, procurement is a missed opportunity. Executives are often concerned about linking sourcing success to financial business outcomes, such as operating profit and working capital -- unsure of the proper systems and processes to create this linkage -- and this applies inertia to procurement innovation efforts. Further, financial executives tend to look at categories of spend individually, such as raw materials, machinery, plant/facility services, utilities and MRO. Executives rarely see the magnitude of overall spend that these categories represent, but when added together, these categories often amount to between several to hundreds of millions of dollars, depending on the size of the organization.

Once the potential for savings is realized, manufacturing companies must assess where their greatest investments are made and how the procurement function can be of benefit to each category. Manufacturers generally make significant investment in machinery, equipment and facilities. The next largest investment is commonly in inventories: raw materials, subassemblies, work-in-process, finished goods, MRO and consumables.

A procurement team can make a significantly positive impact to the level and quality of inventories that will result in lower investment requirements, more efficient production, better utilization of factory floor space, and better service and product to the customers -- in other words, affecting the entire production and cash cycles.

Understanding the Focus

Focus is almost always initially on inventory turns, minimizing inventory levels to reduce investment and thus lower inventory carrying costs. Procurement organizations can assist operations in optimizing owned inventory levels by implementing vendor-managed inventory programs, just-in-time deliveries and consignment programs. By working closer with material planners and production schedulers, procurement can furthermore gain insights into the demand schedules, enabling them to work with suppliers to build the on-time and flexible deliveries that will result in lower inventories on hand, optimizing order sizes, flow of materials, etc.

Better understanding of material requirements through cooperation with product design teams can lead to changes in the material requirements that create opportunities for substitution of raw materials and/or commonality of parts, reducing the total number of SKUs required and the level of inventories that need to be on the manufacturing floor at any point in time. A subsequent outcome of reduced inventory levels is reduced obsolescence and damaged inventories. The longer a raw material or sub-assembly is sitting on the shop floor, the more likely it is to become obsolete or damaged. This is a cost that is normally borne by the manufacturer, an obvious profit leak.

Improvements to the quality of materials acquired that better meet the demands of the manufacturing processes will drive enhanced product manufacturing as the production lines are less likely to stop or produce poor quality product due to less-than-optimal materials. This translates into lower inventories of both raw materials and sub-assemblies, less scrap and re-work, and fewer returns and allowances due to the quality of the production materials, all of which enhance profitability and efficiencies. Fewer quality issues also lessen issues with vendors, as there are fewer vendor returns and claims.

Building strong relationships with key suppliers helps to ensure consistent supply and quality of inputs.Consolidating the supplier base allows for increased leverage with the suppliers, and lessens the administrative burden of managing purchases and payments from and to the suppliers. Developing these key suppliers is particularly helpful when inputs are in short supply or spot purchases are needed.

Additionally, these relationships help keep the procurement team at the forefront of innovation taking place in the industry and with the supplier base, and suppliers can often be a catalyst for improvement in the company’s own material requirements and production processes. More broadly, a roster of innovative suppliers can review the entire supply chain and can assist in identifying opportunities for improvement. Financially, suppliers are more apt to give longer payment terms to favored customers, thus lowering the investment in inventory and improving the company’s cash cycle.

Obviously, these efforts should not be limited to just materials suppliers. Working closely with both service providers and machinery and equipment manufacturers offer additional opportunities for generating efficiencies and reductions in overall investments.

Tracking Savings to the Bottom Line

So bearing this knowledge in mind, how can a CFO ensure procurement is delivering what it needs to, as promised by the procurement team? The CFO and chief procurement officer (CPO) should be able to monitor the progress of each business unit, as well as P&L through a spend portfolio management process. This process allows the source-to-pay organization to develop a “Spend Under Management” plan with each business unit and P&L leader, including forecasting savings, uplifting the Spend Under Management percentage from a typical 25% to 85%+ in each business unit and P&L. The spend portfolio becomes the individual unit’s business plan, which the CFO/CPO monitors through quarterly meetings with each one of the business unit and P&L owners.

Typical questions the CFO should ask to ensure the initiative is on track are:

  • What savings are you achieving/forecasting this quarter and for the year?
  • What is the spend portfolio plan of savings?
  • How much spend is Spend Under Management for the P&L and business unit, and what is the goal short-term and long-term forecast (year end, two years out)?
  • Has the business unit and P&L been trained on Spend Under Management methods and strategies through policies and procedures and best practices?
  • Has the spend portfolio been agreed upon by stakeholders and the sourcing team?
  • What percent of the spend is under contract?
  • What percent of the spend is through e-procurement technology?
  • How does the procurement outsourcing management process work and what percentage of spend goes through this?
  • How does the business unit manage tail-end and spot-buy spend?
  • Can you help me understand the maverick spend and what corrective actions are in place?

Continuing to Maximize the Engagement

Internally, the procurement organization needs to look for ways of continuously improving their own operations through re-engineering their operational processes and increasingly automating processes, leading to a more efficient organization and more efficient interaction with the rest of the company.

Developing strong relationships with internal partners within the organization enables the procurement team to get exposure to other functional and operational areas and tasks, gaining a better understanding of the business as a whole. The CFO has an opportunity to become a steward in helping to develop these strong relationships. As the procurement team drives value, their input into other functional areas will be greatly appreciated and sought after, and the improved business results will lead to a more cohesive and positive team, a team that knows they can make a difference.

Ed Cross is executive director of procurement services for Xchanging Inc., a $1 billion business process, procurement and technology services provider.

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